In brief: the failure of the bailout

[demiurgent]

It's surprisingly simple.

Neither major political party was willing to sacrifice the election to save the nation.

There is nothing more basic than that. Neither party would sacrifice personal power in order to save the economy of the United States of America.

My representative voted Nay. For the first time, I'm considering voting against her in November. I'm certainly calling her office tomorrow to express my deep disappointment in her.

For those who don't want to see the bailout of Wall street firms because gorsh, they's all rich and it's not fair? I hope you really, really enjoy the next ten years.

Comments

Re: UMmmm. Nah.

[snowspinner.livejournal.com]

Here's the problem. Yes, WaMu had credit card divisions that made them money. But to run credit cards, you also need a big pool of money so that when someone goes and buys a $3000 TV on their credit card, you can give Best Buy the $3000.

To finance that, WaMu counts on certain repayments from credit cards and from mortgages. But a chunk of their mortgages were defaulting. That's fine - defaults are factored into the system. You liquidate the underlying asset - the house, take a loss, but the loss, on average, is outweighed by the gains on the good mortgages.

Except here, because of bad lending practices, the default rate was higher than expected. So there are a lot more losses than expected.

So at this point, we've blown through Plan A (Have the repayments on mortgages and credit cards provide enough liquidity to cover purchases and bank withdrawals), Plan B (Liquidate underlying assets on the bad mortgages and take manageable losses), and are on Plan C - liquidate lots of mortgages, take a nasty write-down, lose lots of value, and stagger onward.

Except that WaMu is at Plan C along with dozens of other mortgage holders. So many, in fact, that the housing market is oversaturated. They can't actually sell the houses. And on top of that, since selling a house usually means that somebody has to take out a loan, they need a bank with sufficient cash on hand to splash out a mortgage. So there's no credit for anyone to buy a house, and there are too many houses on the market to sell one. Thus the underlying assets have become illiquid. And all of that cash flow is gone.

Then someone goes and buys a TV at Best Buy, or takes money out of their checking account. And WaMu has to cover it with cash. Then word gets out that WaMu is running low on cash, and all the people with money in their checking accounts panic and take it out while it's still there to take. And poof - WaMu stops having the liquidity to cover its debts and goes under.

Now yes, they do get bought up - because they still have tangible assets. They have existing credit card debt and they have houses. So they're still a sound long-term investment. But in the short to medium term, you have banks that can't extend new credit, which leads to the machinery of the economy seizing up. And unless you find a way to get new credit out there, you get closer and closer to a massive cascading system failure.

That's what the bailout does - it steps in and liquidates the illiquid assets (mortgages) at a loss. A nasty loss - but it's at least a loss that replaces them, for the banks, with liquid assets so that commerce can resume.

Notably, and this is a key point about the $700 billion, if it's managed at all sensibly, it pays for itself. Because the government buys mortgages for pennies on the dollar, sits on them until the housing market regains liquidity, and then starts selling them off. If they buy a mortgage for 10 cents on the dollar then their opportunity to turn a profit on it once the market recovers is enormous. All that's needed is an institution with the capital to be able to afford to sit on an investment like that for a decade. And the government can.

It's a fantastic plan for the government in that regard. They get to make a great investment, sell it at sizable profit, and apply the profit to the federal debt, to shoring up social security, or to anything else they want. If I had $700 billion sitting around, I'd be all over those mortgages. They're great investments. If you have the raw capital to be able to pick them up in bulk and sit on them for a decade.