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…