Bail and Rescue - What it REALLY Means

This week I've been all up in arms with talk of a government bail out of Wall Street. I've watched the news broadcasters attempt to explain what it means. I have to say, I'm still confused and angry. I don't get it - not completely. I'm not a stupid person, either, it's just not my field of expertise.

Yesterday, April sent out a fantastic, dummied-down summary of what the bail out really means. And I FINALLY understand the full issue. Thank you, April! Thank you for completing your higher education in THIS field! Thank you for dummying it down for people like me who have expertise in other areas. I still don't like the idea of the bail out, but then I think it's the better of two options: 1. leave it as it is and let the chips fall (baaaaad) or 2. rescue and failing economy created largely by people who should have known better, who've been here before and should have learned from their mistakes. In the end, I'll take the latter.

Here's what April wrote:
So everyone keeps asking me to explain what is going on with the financial markets and I've tried to find an answer that doesn't sound like a long winded economist. This is the short answer to a very complicate problem.

We've destroyed confidence in our system because we overspent, deceived, lied, and got in WAY over our head and the government's liaise faire policies for the last decade allowed it to happen. Now no one trusts anyone anymore which is stopping the world economy in its tracks. The only way to restart the flow of money and economic activity is to gain back the trust, which is the backbone of our economy, and the only way that can happen is with transparency and regulation.

Want more? Hopefully this can help you understand what you hear on the news:

At the turn of the century, two very interesting things happened; A) the US gov't relinquished a lot of control over the credit markets and B) the average real wage of most Americans decreased (ie they couldn't buy as much as they used to). The decrease in purchasing power was offset by an increase in debt so we continued spending as if our wages had increased. To pay for our overages, we mortgaged our homes and began using our credit cards with greater frequency. In other words we created a high demand for credit which creates a high price (interest rates).

At the same time, the global pool of money began growing (thanks China) and was looking for a safe place to invest (especially after the volatile 90s). When they saw a lot of people in the strongest economy in the world paying a lot to borrow money, they flooded us with easy cash.

Eventually, all the traditional borrowers were satisfied (they didn't need any more money), yet the global pool of money was not, they wanted to lend more and more in order to make more profits. So we began lowering loan requirements (now possible due to the de-regulation) so that non-traditional borrowers could get, say, a home, AND everyone was happy. People had homes and the global pool of money kept getting their profits. Loan requirements got so low that people were getting home loans worth 110% of the home's worth, without any money down, and without proving they had any income at all.

Simply put; we were overspending and the global pool of money was over borrowing.

But we started making things complicated. And this is where the problem lies so pay attention. In order to satisfy the growing demand for US assets (ie the demand to lend the US money), we began breaking up mortgage loans into pieces and then taking a piece of your loan and a piece of my loan and a piece of my dog's loan and bundling them up to make on ONE super fancy loan called a CDO. We then sold, not my loan, but the CDO to the global pool of money. Think of it like a rope made up of many strands. Each strand is a piece of a loan and the entire rope is what we sold.

That would OK if my loan was as safe as your loan and my dog's loan but they weren't, yet we sold them as if they were. So, when my dog couldn't pay his mortgage because he doesn't have a job, the strand in every rope his loan was apart of breaks. His ONE bad loan weakens 6 or 7 whole ropes.

Multiply this process over and over again and a bunch of ropes start breaking. Eventually the stores that sell ropes go bust, either because they can't sell anything (who wants bits of rope?) or really, because no one trusts the quality of ANYTHING they sell. Eventually, it gets so bad no on trusts any rope sold anywhere OR anything sold by anyone who sells rope. The system grinds to a halt.

Ever hear of the credit crunch?

That's what has happened. The global pool of money doesn't trust anything so they've stopped lending. No money, no economic activity. Our overspending is no longer financed so we can't make the payments on our boats, our cars, our homes which only breaks more and more strands, and ropes, and businesses selling ropes, and the whole system takes another hit.

Combine this with people's mortgage payments going up due to the adjustable rate mortgages (ARMS) they got 4 or 5 years ago, and I think it's clear that this is a perfect storm. And like a hurricane, it is feeding on its own destruction so it can destroy more.

So what about this 'bailout'?

The reason the global pool of money isn't lending is because they don't trust anyone. This bailout, as opposed to others in the past, is meant to restore trust by taking these bad strands and weak ropes out of the store so the store can sell what is good and get the system moving again.

With the government as the owner of these loans, my dog will be able to go to them and say, "Hey, I can make A house payment, because I walk old ladies across the street, but I can't make my CURRENT house payment." The government has an incentive to re-structure the loan so that my dog can keep his house and so we can get our money back. So they re-structure the loan and no strands break, no ropes break, no stores close.

Without the government, who does my dog go to? His loan is owned by 6 or 7 different people AND no one really knows who those 6 or 7 people are. My dog has a job and can pay something but without anyone to negotiate with, and no one lending money, he can't re-structure his loan so he gets foreclosed on and adds to the destruction.

In theory, this should bring back the trust of the global pool of money and therefore their money, and the stability to our own economy. In a few years' time, house prices should rebound and the government can sell these loans back to the 'free market' and make a profit that hopefully pays for the whole thing. It happened in the 1930s.

Why does it have to be so fast?

How long did it take for Washington Mutual to go bust? Or Lehman Bros? Or AIG? A few days! Without money, companies bleed out fast! And this creates less and less trust in our economic system. Additionally, every day we wait another homeowner's adjustable rate mortgage gets adjusted to a higher interest rate and higher monthly payment which increases the likelihood of foreclosure. It has to be the government and it has to be now.

Think about this: the reason the Great Depression was so bad and so long was because the Federal Government left it to the free market to correct a serious but not catastrophic problem. Had they intervened in 1929, the world would have experienced, yes a recession, but not the disastrous depression it did. That's where we're heading if we don't do something now. Even the most religious free market advocates know that there are times the government has to step in. This is one of them.


Now why couldn't President Bush or Mr Treasury Secretary: Mr Paulson just have said this - explained it.

Oh I know! Pick me!

Because they had no idea people wouldn't just take their word for it. They thought we'd jump, like we have EVERY other time. It's a bit of the syndrome of the Boy Who Cried Wolf. Now we're really in danger and we don't believe it because we've heard so many similar scare tactics and responded.

Last night the Senate passed their version of the "Rescue" or "Bail Out" and added more incentives and more money onto the package.

In the end, it's a sucky choice! I work to keep my credit nose clean and make wise financial decisions with what little extra money I have and now people who are aggressive and careless get to be rescued!? But if they're not, the consequence isn't just a poor shopping season for the holidays....the potential is frightening!

If the University of Utah, my employer, can't make payroll because insurance companies can't pay them because people can't pay the insurance premiums because they'd rather keep their house or feed their children, then I could lose my job and therefore my house and be in the EXACT position I've worked so hard to stay out of. Can't they just take out a loan to make payroll? Well, IF they could take a loan IF lenders were lending, how long would they have to do that before the interest rate crippled them?

If we think it can't happen and won't happen to us, we couldn't be more wrong.

The scary part is that no one knows if this will really work. And my question is: in the future, are the lenders going to allow borrowers to renegotiate rates and payment amounts and therefore be rescued from personal smaller financial crisis? Are they going to pass this 'generosity' on?

It's a bit of a waiting game. But I am more in favor of this rescue then I was before and I understand why we have to pass it. I will call my representative today and ask him to reconsider his vote. Truly, insist on it.