OT - Financial mess 101 ($700 billion bailout)

[F308GTB]

Maybe I'm just a simpleton (the wife would agree with that), but honestly why the need for a bailout? From my understanding, the bailout would be to buy bad debt. Without this umbrella, financial institutions would tank, and the economy would slow due to the lack of new borrowing which could take place. People can't buy house, cars, businesses can't invest in infrastructure, blah blah blah.

So?

In my mind, debt is a bad thing. Shoring up financial institutions that lacked the fiscal control necessary to lend to risky borrowers just so they can make more loans just seems like a recipe for disaster. The problem with our country is that we have a debt culture. Average household credit card debt is around $10k last I check. People buy way too much car and house than necessary. About half the country spends more than they earn.

What the country needs is not a bailout but fiscal responsibility at the consumer and corporate levels.

[Jackdog]

I 'm with you man. The Mortgage Bankers Association said Friday that more than 4 million American homeowners with a mortgage/ 9 percent were either behind on their payments or in foreclosure at the end of June.

In my mind that tells me that 91 percent of American homeowners are paying their notes. WTF?? If it was reversed I would understand the bailout. But 9 percent? $700 BILLION for 9 percent? I don't get it.

[wco81]

$700 billion is the value of the securities based on mortgages.

If it was just bad mortgages, there wouldn't be a big problem. It's the fact that banks around the world put a lot of securities based on mortgages on their balance sheets, representing a lot of wealth.

Remember that the Depression was triggered by the stock market crash. Now consider that the economy now is even more dependent on finance than it was back then.

Lot of businesses depend on short-term borrowing to fund operations. But with these "toxic" assets on balance sheets, institutions aren't lending.

If more prominent institutions go under, it could spiral into more and more bank failures and soon people start to panic, taking money out of banks, etc.

Consider that in the last week and a half, the stock market has lost about a $1 trillion in value. Companies not directly related to Wall Street saw their stock values decline by double-digit percentages.

So who cares? Well some companies use their stock as currency to raise capital.

As for living on debt, yes it's smarter to live within one's means, not borrow to fund consumption of things you really don't need.

But consumer spending is 70% of the GDP. The growth we have is heavily dependent on people buying stuff they really don't need, including buying stuff on credit.

If Americans scaled back spending, then our economy is more like Europe, which has seen 1% lower GDP growth as well as higher unemployment. These factors aren't due only to lower consumer spending but they are affected by it.

[Jackdog]

$700 billion is the value of the securities based on mortgages.

If it was just bad mortgages, there wouldn't be a big problem. It's the fact that banks around the world put a lot of securities based on mortgages on their balance sheets, representing a lot of wealth.

Remember that the Depression was triggered by the stock market crash. Now consider that the economy now is even more dependent on finance than it was back then.

Lot of businesses depend on short-term borrowing to fund operations. But with these "toxic" assets on balance sheets, institutions aren't lending.

If more prominent institutions go under, it could spiral into more and more bank failures and soon people start to panic, taking money out of banks, etc.

Consider that in the last week and a half, the stock market has lost about a $1 trillion in value. Companies not directly related to Wall Street saw their stock values decline by double-digit percentages.

So who cares? Well some companies use their stock as currency to raise capital.

As for living on debt, yes it's smarter to live within one's means, not borrow to fund consumption of things you really don't need.

But consumer spending is 70% of the GDP. The growth we have is heavily dependent on people buying stuff they really don't need, including buying stuff on credit.

If Americans scaled back spending, then our economy is more like Europe, which has seen 1% lower GDP growth as well as higher unemployment. These factors aren't due only to lower consumer spending but they are affected by it.

Thanks man. That makes sense.

[spooky157]

So the government is going to use our tax dollars to buy toxic assets from these banks and remove them from their balance sheets. These securities are beyond worthless. They're just perpetuating the problem with this bailout. They should let the market adjust itself instead of artificially doing so.

[pk500]

This bailout is a no-win situation for everyone. Wall Street's ineptitude is being rewarded by the taxpayers, but as WCO said, this crisis goes way beyond bad mortgages.

If the bailout didn't occur, it would be financial chaos that would affect pension funds, mutual funds, retirement funds, etc., etc., etc.

If this was just about morons living the high life on sub-prime mortgages, I'd say let each and every one of them drown in red ink and live and learn. But so many entities -- stupid homebuyers, deceptive lenders, Wall Street firms, etc. -- took massive hits out of this financial hookah that it was a Woodstock-sized high.

Too many people have the munchies now, so Uncle Sam needs to step in with the bags of Doritos and chips so everyone can come down as easy as possible.

I just hope Wall Street and the financial industry learn from this and never repeat it. Sadly, they won't. Did Chrysler start building better cars after the government bailed it out? No. Bailouts breed laziness. But I think this one is necessary, unfortunately.

Take care,
PK

[wco81]

Moral hazard isn't necessary to make companies take risks.

Once these institutions start to grow, there will be pressure to increase profits every year.

So they will get creative and start to come up with "innovative" instruments and take speculative bets.

And leverage will again be used.

[fsquid]

I believe Chrysler paid back all those loans that they got in the "bailout". Could be wrong though.

[wco81]

This doesn't inspire confidence:

http://www.forbes.com/home/2008/09/23/b ... ilout.html

In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.

"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

[pk500]

This doesn't inspire confidence:

http://www.forbes.com/home/2008/09/23/b ... ilout.html

In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.

"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

Yowza. As someone who is a PR professional, that is piss-poor public relations. Not surprising, coming from a government agency. But still ...

Take care,
PK

[jondiehl]

These securities are beyond worthless.

Quite the opposite actually. They're very valuable, and quite cheap. The government is buying them at such a huge discount that even if every one of them went belly up they'd still probably make some money (the real estate backing the securities still has value, it's not like our homes are worth 70% less than what we owe on them).

I'm not happy about my tax dollars bailing out financial institutions that took risk and got burned, or the idiots that bought more than they can truly afford.

However, if you ground your kids and tell them not to leave their room for a week, and then the house catches fire, you're not going to make them stay inside of a burning house are you? Our fragile economy is that house catching fire, and the federal government had to step in here to try and maintain order and create a stability in order to avoid a complete meltdown.

[RobVarak]

I know that some of you avoid the politics thread like an off the beaten track Thai brothel, but there have been several excellent links posted in there with details about the crisis.

[JackB1]

This bailout is a no-win situation for everyone. Wall Street's ineptitude is being rewarded by the taxpayers, but as WCO said, this crisis goes way beyond bad mortgages.

If the bailout didn't occur, it would be financial chaos that would affect pension funds, mutual funds, retirement funds, etc., etc., etc.

If this was just about morons living the high life on sub-prime mortgages, I'd say let each and every one of them drown in red ink and live and learn. But so many entities -- stupid homebuyers, deceptive lenders, Wall Street firms, etc. -- took massive hits out of this financial hookah that it was a Woodstock-sized high.

Too many people have the munchies now, so Uncle Sam needs to step in with the bags of Doritos and chips so everyone can come down as easy as possible.

I just hope Wall Street and the financial industry learn from this and never repeat it. Sadly, they won't. Did Chrysler start building better cars after the government bailed it out? No. Bailouts breed laziness. But I think this one is necessary, unfortunately.

Take care,
PK

Why isn't the gov't taking more time to evaluate this situation in great depth? And how do they come up with this $700 Billion figure? A bailout is bad enough, but a quick bailout without much thought put into it is worse. There's got to be some middle ground here. We can't just come up with a figure and then decide how to divide it up. That will just create more chaos. This situation is so complicated, I don't know why they are trying to pass this thing through so quickly? I just read that a bill is already in the House and Senate waiting approval.

[pk500]

Why isn't the gov't taking more time to evaluate this situation in great depth?

Because that kind of time isn't available, from all accounts. For example, I've read where both Buffett and T. Boone Pickens have stressed that something must be done very quickly because the financial markets teeter on the edge of meltdown.

Just look at how AIG, Lehman Bros. and Bear Stearns crumbled within a matter of days. This whole thing apparently is unfolding at the speed of a line of dominoes collapsing, not individual leaves drifting off trees in a fall breeze and fluttering gently to the ground.

Take care,
PK

[JRod]

PK,

I agree with your points except for a few.

You keep banging on about deceptive loan practices and 'stupid' home buyers.

After reading up more on this while there is no doubt these two things did occure. A lot of this type of lending was predicated that home values were going to rise and buyers could refinance later. The fact is that not all of the loans were done with deceptive loan practices or stupid homebuyers.

I would say that there were too many banks willing to give out marginal loans in the face of the housing bubble bursting. When it did burst, all these banks had loans that were bad. Home values were less than expected. Rates increased. So now people where in a home that you couldn't sell without taking a loss and there was a line of product to refinance to keep you in your home.

That's how it affected "Main Street". It's far more complex how it affected Wall Street. Banks couldn't lend to other banks. Which decreases the line of loans banks can offer to you and me.

I barely understand this problem. But from reading up on it, we aren't going to give the banks money. The US government is lending them the money with the hopes that we are guying the loans cheap and they will increase in value. When the US offload them, it will make money but like any investment there are risks.

It also seems that we aren't losing the 700 billion. Some experts say we could lose 100 billion to making money.

Paulsen has done a horrible job of selling this to the American people. The liberal bloggers are taking this as a 700b free check to the greedy banks, which isn't the truth. And the reps in congress seem to be against this plan because the dems rewrote parts of the legislation.

Like PK said, it seems dire and money needs to be infused, so that more banks don't go under.

[pk500]

PK,

I agree with your points except for a few.

(SNIP for brevity)

I would say that there were too many banks willing to give out marginal loans in the face of the housing bubble bursting. When it did burst, all these banks had loans that were bad.

How is this not deceptive? The banks knew this was risky lending yet proceeded to push these loans to consumers with very marginal credit like LSD tablets being pushed at Max Yasgur's farm in August 1969.

Take care,
PK

[webdanzer]

I know that some of you avoid the politics thread like an off the beaten track Thai brothel...

The banks knew this was risky lending yet proceeded to push these loans to consumers with very marginal credit like LSD tablets being pushed at Max Yasgur's farm in August 1969.

You know, as I recognize these to be quite the typical sort of analogy employed here to promote understanding, I can't feel but proud to associate myself with this upstanding community...

[wco81]

They pushed those loans because they could sell them on the secondary market to Wall Street.

Let's say they had $10 million in capital to lend. For simplicity's sake, let's say they made 10 loans of $1 million each.

Now, they could just hold onto those loans and collect the mortgage payments and make a good return.

Or they could sell those $10 million in loans in the secondary market and make 10 more loans. What's good about this is that loan officers have made commissions on 20 transactions instead of 10.

For Wall Street, they were only too happy to buy up mortgages, because while real estate was appreciating 20% or more in some areas, the value of the mortgages they converted into securities became worth more and more.

They also collect fees on converting those mortgages into securities. Then when they trade those securities, more opportunities for profits.

The investment banks needed more mortgages to feed the securitization and trading machine. So they worked with or even bought lenders on their own as well as loan processors (I heard guys with laptops in hotel rooms) to push through as many mortgages through the system as possible.

So they didn't care about loan standards or the qualifications of the borrowers. Or the fact that many of them couldn't afford a 20% down-payment or even a 10% down-payment.

For loan brokers, they had to tell borrowers not to worry about the interest rates resetting and the payments becoming unaffordable. The values would continue going up double-digits so they could refinance or sell their home for a big profit and pay off the mortgages before payments become unaffordable.

In places like Miami, this drew flippers, who signed up for 4 or 5 mortgages at a time, with the intent of selling condos a year or even a few months later.

It worked well for a year or two. Then the music stopped playing and all the chairs were taken away.

[F308GTB]

For Wall Street, they were only too happy to buy up mortgages, because while real estate was appreciating 20% or more in some areas, the value of the mortgages they converted into securities became worth more and more.

So Wall Street was predicting default mortgages. Just buying mortgages means Wall Street is making a steady 6-8% annual unless it was an ARM. A safe investment, sure, but probably not up to Wall Street standards compared to mutual funds. Wouldn't the value of a mortgage only increase is 1) the property appreciated and 2) the borrower defaulted?

[wco81]

No I don't think they were predicting defaults at all.

You have to remember that the stock market wasn't appreciating that much earlier in this decade.

So what became hot were things like REITs, international stocks and commodities. And stocks in some sectors like home builders.

These mortgage-backed securities were lucrative too. They weren't just making 6% return or whatever the mortgage rates were. They made fees on converting the mortgages to securities. Then another division made money trading the securities. Then companies like AIG and others made money selling credit default swaps, which insured the valued of those securities.

Then the credit agencies gave high ratings to these institutions despite the speculative nature of these securities. Some Wall Street firms didn't get as deeply into these as other firms. But they were generating such profits that eventually all of them did, including many foreign institutions, which may be a part of this bailout.

Wall Street didn't think the subprime mortgages would default. Again, they also expected continued appreciation in real estate. But the firms supposedly protected themselves by holding securities based on higher-quality mortgages too. In fact, the subprime part of their portfolio was small.

When real estate stopped growing and people saw defaults coming, people stopped buying all mortgages securities, not just the ones based on the "bad" subprime mortgages.

[F308GTB]

So far the world isn't imploding...

http://finance.yahoo.com/intlindices?e=americas
Click on Asia and Europe and you'll find world markets haven't tanked over concern of no bailout yet.

Chatting with the wife last night/this morning, if either of us were made king (or queen) for a day, we'd say, "You want money? We'll give you a loan." No buying bad loans from these turds, but straight up loans to companies. Seems that would reduce the burden to the taxpayer while effectively improving cash flow for troubled entities.

The free market certainly seems to be working. With Chase gobbling up WaMu, it shows that the strong survive and the weak wither away. I'd much rather see contraction of companies with takeovers than propping up poorly run organizations.

Seems like the American public knows what it wants - no bailout. Calls of disapproval for a bailout outnumber call of support by a few orders of magnitude.

[JackB1]

Will there be any regulation on how all this payback money is to be used? I would hate to see these banks using our taxpayer dollars to keep paying their exec's bonuses and such. This money needs to be used responsibly.
Am I disillusional?

[RobVarak]

So far the world isn't imploding...

http://finance.yahoo.com/intlindices?e=americas
Click on Asia and Europe and you'll find world markets haven't tanked over concern of no bailout yet.

Chatting with the wife last night/this morning, if either of us were made king (or queen) for a day, we'd say, "You want money? We'll give you a loan." No buying bad loans from these turds, but straight up loans to companies. Seems that would reduce the burden to the taxpayer while effectively improving cash flow for troubled entities.

The free market certainly seems to be working. With Chase gobbling up WaMu, it shows that the strong survive and the weak wither away. I'd much rather see contraction of companies with takeovers than propping up poorly run organizations.

Seems like the American public knows what it wants - no bailout. Calls of disapproval for a bailout outnumber call of support by a few orders of magnitude.

I think you make several presumptions that are not necessarily true. The fact that the markets haven't plunged isn't a sign that there isn't still a tremendous systemic problem. Investors seem to be still restraining themselves waiting to see what's going to come out of Washington. They still believe there will be a plan of some sort. If that belief erodes, most think that the market will erode with it.

The WaMu failure required the FDIC to act as a de facto RTC, not the role that it is intended to play. If the market were really as operative as you suggest, there would have been buyers for WaMu before it failed. The fact that there were not is an indication that the credit markets continue to be paralyzed.

The weak may "wither away" but businesses holding over $30b in WaMu debt are screwed and stuck with worthless paper. Furthermore, we now have yet one more fewer national bank, meaning that more of the deposits are at risk in fewer institutions...a precarious turn of events.

The problem with extending loans is that there is insufficient willingness to trade in the commercial paper markets for the banks to be able to make principal payments on a regular basis if the credit crunch doesn't ease.

I'm a HUGE advocate of free markets, but the combination of factors that have imperiled these markets are unique in our history.

Americans may be against the bailout, but that's natural given the nature of this beast. Prices remain stable. Jobs aren't being lost at an alarming rate. Those are their most direct indicators of the economy. They don't realize that they are about 1/2 domino from the credit cruch threatening liquidity and facing a scenario where they will go to the ATM or bank on Monday and find it empty. Understanding this requires a leap to abstract thought which many are unable or unwilling to make.

I'd feel better if Barney Frank and Chis Dodd, two of the most culpable individuals in this mess, weren't involved. I'd feel better if the CEO's upon whom we are depending aren't the very same that got us into the trouble to begin with. But it's an imperfect world, and events aren't going to wait for us to create the perfect scenario or structure for the deal. This is the worst time to let the best be the enemy of the good.

[GameSeven]

700 Billion dollars!

[JackB1]

With this $700 billion bailout looming, I can't help but think about all the billions spent in Iraq month after month? And for what? A democracy in Iraq? And that's the BEST case scenario. Doesn't seem right to watch us try and rebuild a country in the middle east, while our own is falling apart. How long before there are only a couple of banks that survive controlling all our money? The future sure looks scary.