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Dustin LindenSmith

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philosophical, or big picture questions about this financial crisis

I need someone to explain to me why the economic system is going to collapse if some suitable bailout arrangement isn't arranged in the next week. It has already been nearly two weeks since the alarms were first raised, and everything seems to be going fine so far. If anything, the markets are ripe for picking at the moment, if you happen to be one of those lucky ones with cash to spend. (Of course, the question is, what to buy? Paul Krugman's personal assets are in money markets right now, but he says that even those aren't doing well. My own advisor is recommending T-bill mutual funds.)

I'm trying to keep it simple in my mind how this works. Treasury Secretary Paulson, himself a former Goldman Sachs exec, is telling us that the sky's gonna fall. Isn't it possible that he sees his own sky about to fall, along with that of most of his closest friends, because of the egregiously greedy financial practices that have been undertaken by the major banks and investment houses? I mean really, not to put too fine a point on it, this stuff reeks to high heaven. In this week's Sunday New York Times, I read about these complex credit derivatives that allow asset-rich insurance giants like AIG to leverage their credit rating to insure loans purchased by banks and other corporations, which in turn are resold to other banks as attractive debt packages that are supposed to be comprised of "blue-chip" loans and debts that would never default... Then in due course, they find out that these "blue-chip" loans really contain a whole bunch of those sub-prime mortgages that are already in default or will be within the next 2 years due to their built-in rising interest rates, and when the analysts start looking at everyone's balance sheets to see who has the actual cash to cover off these loans, insurance policies, and other credit derivatives, they figure out that this is just a very big house of cards.

In that light, doesn't it just seem like this is a bubble that's meant to burst? The Treasury didn't step up when Silicon Valley went up in flames in 1999, and in that one, thousands of Main Street investors lost millions. When any given sector of the market, even the investment banking sector, starts playing too fast and loose (in this case, by creating spectacularly complex investment instruments to make seemingly endless gobs of money), I don't see any case that supports a government bailout more than any other.

Furthermore, I'm not convinced that the amount is even all that significant. It's the same as what's been spent on the Iraq war so far, and the US economy hasn't choked yet.. Why can't the financial sector absorb the same amount from within itself? And -- let's face it, honestly -- why can't we be seriously discussing employee compensation within the financial services sector? If this system is in the crisis we're told it is, then the belt-tightening by definition must begin with the executives. Any annual compensation packages of over a million dollars in any form (i.e. salary, bonuses, stock options, whatever) need to be stayed, if not overturned, if the taxpayer is about to bail out this entire industry. I could not stomach a whit less than that.

My ignorance of the finer points of economics is clear. But at the macro level, that's how I see this.

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savia September 30th, 2008
It all has to do with credit and liquidity.

Basically, the problem is that the credit that was being offered by European & other banks to American banks was based on mortgage-backed guarantees. When the mortgage crisis hit, that credit started to slow down, with a lot of banks no longer wanting to lend to American banks.

So, what does this mean for the economy? Well, that credit is what keeps regular businesses afloat. Like it or not, credit is one of the major pillars of capitalism, and it's what allows for economic growth. If that credit dries up (as it might if this is not solved pretty damned fast), then there will be no credit for businesses who rely on a steady stream of credit to do day-to-day operations. It's the foundation of capitalism. My business, for instance, uses credit all the time to do things like purchase airfare to go see clients, to purchase equipment, etc. We then pay off the credit in full with earnings made the following month, and then put away the surplus. Most businesses work that way... it's how you stay afloat and build capital for future larger expenses. It's often how businesses deal with payroll - they use credit to pay their bills, including paying their employees and contractors.

So, if credit dries up for our major institutions, which it will if the mortgage crisis continues apace, then credit will by default dry up for American businesses, which means... everyone is royally screwed. Without credit, there's no money flowing through our economy. Which means a recession like no one has seen since 1929. Which means chaos.

So. That's why it's so important.

Now, the last time we had a major mortgage crisis in this country, Roosevelt pushed for renegotiation of mortgages to enable people to make their payments. It's much better to renegotiate a mortgage than to send it into forclosure. The New Deal also set up economic safeguards for average people. Of course, Republicans have been chipping away at that for decades.

Anyway, what needs to happen along with some kind of bailout is a massive effort to renegotiate mortgages to make sure that people can pay them, along with some strict regulations on Wall Street and bank activity to keep this kind of thing from happening again. It all started with the subprime lending mess... massive predatory lending, people being given credit who had no business getting that much credit, etc. The banks got incredibly short-sighted and incredibly greedy, and this is what happened. Without deregulation, this wouldn't have happened. Kind of like when energy was deregulated in California, it led directly to the energy mess several years later.

Does that make it any clearer?

Edited at 2008-09-30 03:59 pm (UTC)

savia September 30th, 2008
Also, this is how I've seen it explained by economists, so I might be missing some nuance in the translation, but I think that's the gist of it. And the problem is that in the news cycle, reporters should be explaining this problem every time they talk about the bailout rather than just talking about its passage or failure, because I think the vast majority of Americans just don't get it, don't understand why we got into this mess, and don't understand why reregulation is important.

vyus September 30th, 2008
as long as they talk about how it's financed, too :)

high liquidity in the credit markets = low interest rates for most classes of borrowers. but if credit markets "freeze up" (which is a sort of misnomer), then the cost of borrowing (interest rates for borrowers) goes way up.

we call that inflation.

meanwhile, if we go forward with the bailout without funding this correctly (balancing the budget), then we're just issuing more money into the money system, making existing dollars worth less.

we also call that inflation.

so the question is, which avenue causes less inflation? and why is less inflation a bad thing?

baal_kriah September 30th, 2008
I prefer this explanation:

"Editors - I am a retired federal law enforcement officer who investigated several multimillion-dollar fraud schemes during my career. The biggest "red flag" in those schemes was the forceful statement of the fraudsters to the victims that you must sign on to this "opportunity" immediately or you will lose your chance to take advantage of the plan. I am not making that up - that is what they do.

The frightening thing to me is that the White House and Bush's minion, Treasury Secretary Henry Paulson, must have read the same book to get their ill-advised bailout passed. It sure sounds familiar to me. What the hell is the hurry? Take time to work it out.


San Francisco"

Edited at 2008-09-30 05:22 pm (UTC)

vyus September 30th, 2008
the bailout seems to be about helping businesses that put us in this situation. these businesses and people are capitalism failures, and issues like executive compensation are included? this deserves vulgarity. i can't imagine any socialist or capitalist (who aren't the executives involved) in their right mind thinking this is a good idea.

meanwhile, the symptom of tight credit will be offset by higher interest rates. the real question is how high interest rates need to be. but people don't like that question, because (like the question "should oil be cheap") it requires changes and will send shocks through the system. but it's not necessarily bad. i feel like we've got a generation of americans (and businesses) that feel entitled to cheap money indefinitely. they don't realize that 10% interest rates for mortgages used to be a pretty good rate.

the reason the US, on the whole, needs to borrow is to finance it's twin deficits: the budget deficit and the trade deficit. this deficit trickles down to the business models of all the business across the board. from a system perspective, all our businesses are running on a model that spends more than it makes indefinitely.

of course it's going to fail. this is where we have a collective zen moment.

and what the media ought to be doing is saying how the plan will help that, on a line-by-line level. after all, we're talking about a government that lost $80 billion in iraq over a few years with no record of where it went. we're leery of writing blank checks.

being a taxpayer the last few years has really sucked. we're tired of it.

. . . . . .

so, to answer the questions:

1. loss of jobs and other cutbacks due to higher cost of borrowing
1a. please note this is no different from the cost of gas going up. let's just call this inflation.
2. loss of jobs in finance and related sectors
2a. these jobs probably ought to go. they were built on an unsustainable model. those people should get new jobs.
3. loss of "paper-gains" (appreciation of assets that aren't sold) in investments, real estate, 401ks, pensions, etc
3a. it may be a pain, but the worth of something isn't set until you sell it. complaining that the value of an asset lowing in value is pretty much an irrational rant.
4. economic impacts of everyone spending less.
4a. this is already happening.

vyus September 30th, 2008
credit markets won't freeze, the price of borrowing just goes up. which is good -- because risk has been understated for over ten years now.

and that higher cost of credit isn't somehow different than the higher cost of fuel or anything else. Business 101: money is an input to business. the cost of it going up has to be dealt with the same way a business deals with higher fuel prices. it's inflation, and the US is stuck in it no matter how hard our damn officials try to say we're not.

but you know what? if we bailout these guys without balancing our budget, we're essentially printing more money, which means we're causing inflation anyway even if it keeps the cost of borrowing down (there's no reason to believe that it won't, btw, since risk has been understated for years now, and risk is a main factor into the cost of borrowing) and the cost of borrowing, gas, food, and everything will still go up.

pretty stupid bailout, huh?

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