My Thoughts On Paulson's $700 Billion Bailout

My Thoughts On Paulson's $700 Billion Bailout


First things first…an explanation of what’s going on.

Basically, nobody is willing to buy these packages of mortgages. This is why banks are having cash flow problems and not lending money…because they can’t sell these packages and they’re worried they won’t have enough liquid assets.

But let’s be clear…a good 80% of these mortgages are perfectly good mortgages. Another 10% could go either way and the other 10% are probably dogs. But this is why the government has to step in…because the “free market” won’t. And frankly, the market should because these assets are being offered up at discounted prices. Still, investors won’t bite and so we have the crisis.

So one thing everybody needs to be VERY clear about is we’re not just throwing $700B down a hole and saying goodbye to it. This is an investment.

Now then, what is Paulson’s plan?

The quick and easy explanation is he wants to take $700B and buy up these assets in stages. $100B here, $100B there, buying packages for 40 cents on the dollar, etc. And so the market will get rid of these packages that nobody wants right now and will get flooded with good paper (money) that it needs to keep moving. This will give our banks the ability to start lending again, which they haven’t been able to do because nobody will buy these mortgages.

It’s not as simple as that, but those are the basics. And, as mentioned, we’ll eventually sell these assets when they become valuable again.

What’s the net for taxpayers?

Well, we could lose $200B or we could make $200B. So there are risks here, but the upside of the government buying these assets is the fact that we can actually hold them until they might actually be worth a great deal more than we buy them for. So think of the government as the world’s biggest corporation that is so heavily leveraged across the world that it simply can’t fail…at least at this point.

So why aren’t we just going with the plan as is?

Because Paulson’s plan badly needs oversight. And while he claims his 2-page outline was simply that, an outline, there was a section in there where it certainly seemed like the exact opposite of oversight. Also, if the government is going to buy these assets, it needs mechanisms to help out people who can’t pay their mortgages and pay back the taxpayers if we make a profit. Essentially, “Main Street” needs to believe that they’re going to get help too, and let’s be honest…if we’re going to buy $700B worth of mortgages we’ll ultimately benefit from fewer people defaulting, right? So a stimulus package should be part of any bailout plan.

Also, while I think there should be limits placed on CEO and executive pay, that’s not as important to me as the first three I’ve mentioned (oversight, payback and mortgage help). In fact, I agree with Paulson that it could hurt acceptance of the bailout in the private sector because CEOs will balk at having their salaries cut so drastically. McCain wants a $400,00K limit and I believe Obama has said $2M. But again, I think this could hurt acceptance of the bailout money.

So how did the candidates respond to this plan?

Obama essentially outlines the four things I’ve covered. McCain has three of them, with the only thing missing being the stimulus package for “Main Street.” In fact, McCain has flatly said no to a bailout for taxpayers. Honestly, I think this will hurt him because EVERYBODY I’ve talked to, whether they be Repub, Dem or Indy says “Where’s my piece?”

Oh, and by the way…Bush just wanted to go with Paulson’s two page plan and leave the power of all this money in one person’s hands. So there’s some more sage wisdom from the Oval Office. My how he’ll be missed.

So how will all of this ultimately unfold?

Who knows, but they better figure out something soon or else risk some serious economic consequences. Because if banks don’t get this cash, then they could fail. And then the walls could all start come tumbling down. That’s why everybody is scrambling right now. They are scared $#!+less of the repercussions if we don’t do something.

In any event, I hope this has been informative. Obviously I’m not a financial expert, but I’ve tried to pay close attention over the past week so I could help everybody figure out what’s going on. If I’ve missed something or gotten something wrong, please feel free to correct in the comments section below.

More as it develops…

  • ExiledIndependent

    5-7 years of recession would, 20 years from now, be better than what is being proposed in this bailout.

    “We’re from the government. We’re here to help.”

    There is absolutely zero evidence that the government is capable of doing this right, folks. We’re trying to save ourselves some (very real) pain, and by doing so we’re opening a fiscal Pandora’s Box. Pyrrhic victory, at best.

  • LEC

    Thanks for breaking this down for us in plain english. I work for the government and still didn’t really understand what was going on.

  • kranky kritter

    I agree that opposition to bailing out all the joe-bag-o-donuts home “owners” with onerous mortgages will hurt McCain.

    But ultimately I’m more interested in the wisdom of it. What precisely would such a bailout look like?

    Here’s the thing. Real estate prices had been growing at unrealistic and unsustainable rates for some time, which is what led to the raft of bad risk loans. If you look at historical prices and project from those, disregarding the bubble growth, then you see that current valuations are in a far more sensible ballpark than the prices that existed when the bad loans were issued.

    So, there are now lots of folks out there who took loans they couldn’t afford to buy houses at inflated prices. Picking a few numbers out of my rectum, let’s suppose your garden variety Joe Bad Timing has a mortgage of let’s say $320,000 on a house now valued at 210,000. In that instance, what’s a better bailout than declaring bankruptcy and walking away? Maybe you expand some asset protections, maybe not, I’m not sure what gets protected. I could, for example see protecting some or all of retirement assets if they aren’t protected.

    But what’s the point of sustaining the situation where we’ve got a bunch of Joe Bad Timings who get to keep their houses as a giant financial burden? That hypothetical house is unlikely to see its $320,000 valuation again any time soon.

    Ultimately, what makes sense is to walk away from what is now a terrible investment. Then, the best bailout going forward is to find a way to extend folks new post-bankruptcy credit to buy another house (or even the same one) at a sensible market rate. BUT, only if that person is genuinely credit-worthy according to some sensible standard when income is compared to expected expenses.

    Home ownership is not a sacred civil right. It’s something to aspire to, but it’s not even a fantastic thing for everyone compared to renting. It depends on your circumstances and lifestyle and life plans and a variety of other variables. Speculation and greed are certainly a part of this story, but extending credit to bad risks is also a part of the story. When the dust settles, we need a situation where a chastened market looks serious askance at every prospective borrower.

    I am seeing anecdotal stories in the news of folks with less income than I buying bigger nicer homes than I, much closer to downtown, and crying poor mouth that they’re getting foreclosed upon because they can’t afford their new monthly cost now that their 3-year ARM has expired. There are lots of folks like me who made a sound decision about where and what they could afford to buy based on their income and the prices when they bought. We all object to bailing out folks who MUST have known when they signed that they really didn’t have a plan for meeting the larger payment that might well come.

  • B.Tau

    Taxpayers won’t get any meaningful return on their investment unless the proposed equity ride passes. By acquiring shares of troubled banks that accept the bailout, taxpayers might indeed get a bargain.

    Also, remember, that its not plain old vanilla mortgages that are on the chopping block, its mortgage-backed securities. Even if 80% of those mortgage holders can afford the home, their mortgages have been chopped up, repacked and sold off as financial instruments. The government is not simply buying up individual mortgages, they’re buying up mortgage-backed securities. Even if as little as 20% of the assets in the security are rotten, its not necessarily a strong security.

  • BenG


    Good job with the basic premise here. I agree, we collectively HAVE to do something to get Wall St. out of the mess they’ve created with our Government’s easy credit line over the past years, going all the way back to Paul Volker and the Clinton admin.

    A few problems with your analysis. First, we’re not throwing tax payer cash at the banks to fix this problem, as you suggested in the last paragraph. Banks aren’t having a cash flow problem, the Investment Banks are having a credit meltdown. A gross lack of liquidity in the market- the currency that banks lend to other banks and corporations borrow for investments – has frozen up due to the failures of some major Investment Houses and the worlds largest Insurance Co – AIG. When the lack of trust in our financial markets caused a ‘run’ on money market funds which scared the freakin pants off of the Fed and Treasury Depts. it became obvious to everyone that some BIG FIX needed to get done

    The rest of your summary is good, except for the estimate of the initial cost of these Mortgage Back Securities that the Gov would pay. You said .40c on the dollar, I’ve heard as much as .65c which would mean, after the Fed issues bonds and the other costs of doing business, we may be lucky to earn anywhere from 8% to 15% on our ‘investment’ if all goes well. Good luck! And welcome to the Credit Swap Business, my friend.

  • J. Harden

    Nicely done, Justin.

    Taxpayers won’t get any meaningful return on their investment unless the proposed equity ride passes.

    This is a good point. If this works…then I think we should all revisit the much ignorantly maligned concept of privatizing social security. The fact is, even with these shitty equities, the tax payers are getting a better deal than the social security trust currently gives them.

    I see a watershed moment on the brink.

  • Ken Williamson

    How does it taste to have a $700 billion ball of crap crammed down your throat
    while being held down and your mouth pried open by Henry Paulson, George W. Bush and Ben Bernanke. Well it’s leaving a really nasty taste in my mouth. George W. Bush and his criminal clowns crammed the Iraq war down out throats in 2002. We cannot let these political bandits cram this crap down our throats too. The
    American people must stand up and make their voices heard. We need to track down each and every criminal involved in this catastrophe, prosecute them to the fullest extent of the law, and lock these clowns away for life.

    I blogged about this on
    Check it out.

  • Mari

    Looking at the stock market and my husband’s 401 AND the rate of people cashing in money markets, it seems evident that privatizing Social Security is a guarantee to move 20 million+ seniors into poverty. The best part of Social Security is not the return, it’s the Security.