What does the “Bailout” do, how, and why.

After much focus on how neither Obama or McCain explained the economic situation on Friday’s debate I was pleasantly surprised when during a campaign stop yesterday Obama effectively conveyed at its most basic sense what the bailout is meant to do. He mentioned that if you see your neighbors house catch on fire you should do something about it, even though you know that your neighbor has always been irresponsible, and you knew that he never stopped smoking in bed. As much as you might believe that your neighbor should suffer the consequences of their house burning down, their house might just make your own house catch on fire too! So if the “what” is your question thats your answer, weak but an answer.

If you are wondering how the bailout works I will reserve all judgement (as best as I can) until the end, and explain. The 110 page bill (yes I’ve read it and its that long) currently going through Washington does several things:

  1. Give the Treasury the authority and cash to purchase the toxic bonds I mentioned in the last post.
  2. Focus on bailing out pension funds and government entities like cities and counties that heavily depend on these bonds working.
  3. Create a board that reviews how the bailout money is managed.
  4. A) The top executive pay of whichever company asks for assistance will be scrutinized to limit excessive risk-taking, ie: focus their pay on long-term growth and not quick and risky short-term reward. B) No golden parachute allowed, if the executive did a bad job and was fired or left the company he cant get a fat goodbye-to-you check.
  5. Temporarily increase the government protection on checking accounts from $100,00 per account to $250,000.
  6. Provide home-owners who are having trouble paying the mortgages more time and even lower interest rates.

So Why does the bailout help?

Buying toxic bonds would probably stop the dropping price of the bonds. Think of a bond as a pill which is made up of many ingredients, which are the loans. Worst case scenarios dictate that about 35-40% of the loans that make up many of these large bonds are bad, meaning they should be worth only 65-60% of what they were sold for. But since banks sold them off and others bought them up as high quality bonds, the current uncertainty of how much they are really worth has made them drop up to 80% or more of their value. So if the government starts buying them for how much they are worth long-term, their prices would become more stable. Banks would have a sense of how much they lost, and how much they still have left over to continue providing all of us with credit.

My thoughts This extreme bill is anything but pleasant to swallow, and with a price tag of 700 billion its easy to see why its easy to hate. Apart from seemingly helping wall-street out and having government budge into how markets work, my main dislikes are that it doesn’t seem to have strong punitive focus over the individuals who authorized much of this crisis to be created, and in some ways encourages the risk-taking to happen all over again.

At the same time the idea that Wall-street is literally getting “bailed” out of a jail of their own making is not entirely true. Up to this day many of the executives at the top of this crisis have lost massive amounts of money, many of them are running out to sell their art collections (Lehman Bros. CEO) and some have lost about 98% of their company stock value (think Bear Stearns, Wachovia, Washington Mutual etc…). In fact unless they have stock investments on the moon, almost all of the wall-street crowd have lost at least 50% or more of their company stock- not painless at all.

While letting all the chips fall would certainly decrease the possibility of such wild risk-taking in the future, we are human and as soon as this group of people were too old or tired of working a new crop of risk-takers will certainly arise. Keep in mind that this kind of economic crisis is not new, 1987 and 1997 had similar crises threatening the world, yes they ended through bailouts too. The world is not about to end, we all need food, clothes, cars and books, and as long as we need those things someone will make them, and without a severe and long crisis make them at a price at which you and I can purchase them.

Being against the bailout is being for alot of good things, but its also loosing sight of the fact that all of our “financial” houses are in the same city. Not doing nothing will hurt far far far more than doing something because in practical terms, your credit card limits will get lower, interest on a car or a house will get higher, companies regardless of size wont be able to get credit, and jobs will be eliminated. Its a simple as that.

3 thoughts on “What does the “Bailout” do, how, and why.

  1. Joyce: I understand what you are getting at, the bill that was passed last Friday (Oct. 3) had some DISGUSTING(!!!!) little pet projects mostly thanks to Nevada Sen. Harry Reid. In fact the entire bill was over 425 pages long!! My post focused solely on the 110 pages of the financial “bailout” or officially named Economic Stabilization Act of 2008.

    I’m pretty sure that the bill would have passed the senate without the extra projects, but Mr Reid took advantage of a national crisis to further his own personal agenda.

    To pass the house the financial part of the bill itself did have changes that would 1)protect homeowners who are stuck with a bad loan agreements and elimination of golden parachutes (for the democrats). 2) More focus on transparency and minimized market interference (for the Market leaning Republicans).

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