Understanding the Bailout
nothinghead
Posts: 270
I've been trying to understand this whole bailout discussion, but to little avail. Economics are not my strong suit, not by a long shot. The only article that I have read that really seems to connect with me is biased and written by someone who is admittedly not an economist.
So, I guess in short, I'm looking for someone more informed than myself to tell me if the following article is on the right track or is a good basis for understanding what is being discussed:
http://www.vate.net/2008/09/bailout-simple-explanation-plea-for.html
So, I guess in short, I'm looking for someone more informed than myself to tell me if the following article is on the right track or is a good basis for understanding what is being discussed:
http://www.vate.net/2008/09/bailout-simple-explanation-plea-for.html
Post edited by Unknown User on
0
Comments
But, that's not to say there aren't more qualified people on this board. JOEJOEJOE is a CPA, so that's certainly a qualification.
OK, here it is in layman's terms.
These big-ass banks and even the little ones too were creating a crapload of home loans with money they were borrowing from the federal reserve and from other banks.
Like sharks around a whale carcass, those banks decided to just start lending with a no holds barred style of lending -meaning that they stopped checking on peoples' credit and repayment ability before approving funds.
The reason they did this is because the federal reserve board, by lowering interest rates, created a housing market boom that made it incredibly profitable to buy and sell homes.
In this rapidly expanding market, it was impossible for banks to remain competitive without lowering their standards.
What's more is that those banks were packaging those home loans together in bunches and selling them off on the open market. Those packages are called "derivatives". Derivatives are a high risk investment tool, which by the way, brought the County of Orange into bankruptcy in 1996, when the County Treasurer thought he could make $$$ investing the County's funds in derivatives.
Getting back to this year....
Because the banks could sell those home loans off in neat little investment packages, they didn't worry about the risks of lending to people who couldn't repay.
Eventually, those people who couldn't repay started defaulting on their loans in large numbers.
The defaults themselves didn't affect the overall market. Instead what happened was investors started realizing what was going on, and they panicked.
Because investors panicked, they stopped buying those derivatives from the banks.
Suddenly, those banks were stuck with a crapload of home loans that they didn't intend to keep for very long.
On top of that, the housing market started to shift back. This was due to an increase in interest rates, and also because the extremely inflated home values from the housing market frenzy were finally beginning to fizzle.
So, what those banks had to do was "write down" their assets to their market value.
You see, the misconception is that the banks have a bunch of foreclosed properties belonging to "subprime" borrowers. That is a misconception.
In actuality, the banks have a bunch of properties with attached debts that are larger than the market value of the properties to which those debts are attached.
When this happens, a bank loses liquidity, which is its ability to produce cash.
So, here's what the bailout is all about...
The government is proposing to spend 700 billion to buy all of those overvalued properties that investors no longer want to buy.
Not only will this relieve the banks of the risk of holding "troubled assets", but it will also leave a whole bunch of cash at the banks' disposal.
The idea is that the banks will use that cash to lend money to small businesses, who rely on loans from banks in order to run their day to day operations.
Meanwhile, it's assumed that when the properties that the government buys eventually go up in value, that the government can sell them at a profit and taxpayers will be rewarded.
http://forums.pearljam.com/showthread.php?t=272825
You should be able to listen to it here.
http://thislife.org/Radio_Episode.aspx?episode=355
They are also supposed to do an update to include everything that has happened so far this next week.
Just my 2 cents.
9/29/04 Boston, 6/28/08 Mansfield, 8/23/09 Chicago, 5/15/10 Hartford
5/17/10 Boston, 10/15/13 Worcester, 10/16/13 Worcester, 10/25/13 Hartford
8/5/16 Fenway, 8/7/16 Fenway
EV Solo: 6/16/11 Boston, 6/18/11 Hartford,
.......will ANYONE be held accountable for this mess?
I doubt very many people would disagree with you there.
http://forums.pearljam.com/showthread.php?t=272825
Sounds likw they are making poor bussines decidions, and are having the gov't bail them out-with our tax dolllars.
Man I need to get in on this. Start a company, run it into the ground and have the feds bail me out. intersting economic system this has degenerated into.,
If anyone ever is held accountable, it will probably be some scapegoat who forgot to pass the buck.
On the surface, it appears as though lenders are most at fault because they exercised the poorest judgement by selling homes to subprime borrowers.
However, from an economist's standpoint, the people most at fault are the Bush Administration and Alan Greenspan of the Federal Reserve Board.
Alan Greenspan initiated the housing boom by lowering interest rates to the point where it caused unheard of inflation.
No responsible economist would ever have lowered interest that low and for that long.
Subprime lending triggered the current crisis. But, what most people overlook is that this crisis would not have as far to fall were it not for the inflation caused by poor decisions at the federal reserve board.
http://forums.pearljam.com/showthread.php?t=272825
Add to this the fact that many of those who lost their jobs lost them due to those jobs being shipped to other countries with no repercussions to the companies that do so.
When the local steel mills were going under and they tried to get help from the government they (the govt) decided that the mills didn't really need help because they were giving multi-million dollar bonuses to the top executives. How times have changed.
yes.
The Taxpayer.
And while i feel that Sponger fails to apply appropriate emphasis to the fundamental market distortion at the bottom of this -- The Federal Reserve itself (and NOT just their "target" rates) -- i think his analysis is actually on the mark.
Once one understands that the banks created the Fed for the general purpose of subsidizing their profits (by using tax payer money as their downpayment) and socializing their losses (via the FDIC and government bailouts, again all with taxpayer money) you begin to understand the real nature of the problem.
And once you get the inherent moral hazard in a system that ONLY guarantees losses to LARGE institutions (because they are "too big to fail") and further encourages the MOST risky investments at the HIGHEST margins by removing the market discipline of market based insurance (the FDIC insures ALL banks the exact same, regardless of the risk they take on and transfer to depositors) then you begin to understand why the problem keeps happening.
The government has effectively institutionalized the encouragement of malinvestment.
:(
If I opened it now would you not understand?
I agree with all that, but you forgot to mention what the 700B will fix!
As you know all these banks have been going bankrupt. And as you should know, all these banks loan to each other, and as you have seen there is somewhat of a domino effect of banks defaulting because they were exposed to each other by having loaned to other banks.
So what this has caused is for all the banks to be scared to lend to each other for fear that the bank they loan to will not be able to repay the loan. This is what they mean by a credit market freeze. When a credit market freezes, interest rates jump because banks feel that there is a higher risk, and therefore need a higher reward for lending (higher interest rates).
Higher interest rates and the general fear of lending causes every company to have a harder time getting loans and if they do manage to get one, they will be at higher interest. This effect could potentially trickle down to all these companies and individual borrowers (Adjustable rate mortgage) and cause them to default. This will in turn make credit markets even tighter and will keep looping until there is a balance reached.
With the bailout, the hope is that the credit markets will loosen and the above effect will not happen.
It's pretty much a controlled demolition (everyone paying a bit more taxes) vs. chucking a bomb at a building and hoping for the best (not doing anything and hoping for the best).
I have an MBA in finance but work for a company that's not doing so well (GM) and am only 25 so I may be totally be misinformed
Bridge School '06 Night 1 & 2
Venice '07 pummeled by the sleet!
Nijmegen '07
Werchter '07
April Fools ~ LA1
I mentioned liquidity. What you are essentially describing is liquidity and the lack thereof. You obviously elaborated a bit more than I did on that particular subject.
You describe increased interest rates as having a negative impact. However, I am of the notion of that interest rates are too, too low.
In fact, more than anything, people need to lose their homes as a result of adjustable rate mortgages and an increase in interest rates.
Housing values are horribly inflated to a point where it's an even bigger problem than people losing their homes.
You see, all of that massive inflation in the housing market was leading to a phenomenon known as a dual economy. This means that fewer and fewer people were able to afford property because property values were being blown out of proportion by low interest rates.
In fact, at its peak in 2006, the housing market created an affordability rate in the single digits in some states.
A dual economy situation would amount to a total failure in everything that society has been working towards in terms of distribution of wealth.
As painful as it may seem, the clock needs to be turned back and people either need to start losing their homes due to overextending themselves, or they need to suffer though a tremendous downward surge in property values.
These things need to happen for the sake of mankind.
You obviously understand markets and the economy, and your views reflect that of most industry experts. However, few people bother to notice that it's not OK for middle class homes to cost a half million dollars. When such homes cost that much, that in it of itself is an indicator that there is something terribly wrong with the economy.
And the reason why politicians like McCain look at an inflated housing market and say things like, "..the economy is strong.." is because he own 10 homes and doesn't have a clue as to what it's like to save money his whole life just so he can own just one modest home in which to raise his family.
People need to lose their homes by the masses. And I say that with the welfare of the hard working american citizen in mind. For the last several years, low interest rates led to a fiscally carniverous free-for-all that was on the verge of bringing society back to the days of the Roman Empire.
That's why I say that when it comes time to hold someone accountable, it shouldn't be lenders who gave money to subprime borrowers. It should be Alan Greenspan for keeping interest rates at record low levels when no responsible economist would ever have recommended doing anything nearly that dangerous.
http://forums.pearljam.com/showthread.php?t=272825
wow, thank you kindly. I feel like that really helped clarify a few things I was struggling to understand.
The part about current housing values is still a little too slippery for me to hold on to. You mention that housing values are horribly inflated, which given the circumstances, seems to make sense. However, everywhere I look, people are putting there houses up for sale at a much lower cost than what they initially paid. This is the housing market reverting back pre-inflation levels then, yes?
My initial thinking was that the proposed bailout plan was a temporary remedy to what is a much larger problem--that even if this money was circulated through the banks and used to buy bad loans, it would not solve the root problem, merely disguise it for a little longer. This discussion seems to back up that assertion. As for that actual root problem, would it be fair to describe it as banks merely selling off loans that they knew were too ridiculous to work and then getting called on their shit? That this in turn is endemic of the danger an economy that doesn't produce any hard goods faces? I mean, it seems like a lot of the money that these banks and investors were making was just trading the same bit of paper back and forth, the whole making money from money idea, yes?
Of course, one of the other signs--besides this conversation--that this was perhaps not in the country's best interest was that it was truly substantial legislation which far reaching impact being ushered in at breakneck speed--the same tactic used to pass the Patriot Act and drag the country into war. Of course, I wanted to understand the issue a little better than simply "go with your cynical instinct." So, again, thank you.
I blame everything that has gone wrong in my life on Bush....I get a cold...its Bush's fault....I fail a test....Bushs fault.....fail to make friends on Moving Train....Bushs fault.
Tell you the truth, I don't think they will ever pin the blame on anyone.
Well, the thing to keep in mind is that in the last, say, 4-5 years, housing values literally increased 200%-300%. That is, a house that once sold for $250,000 in 2002 would've sold for $625,000 in 2005-2006.
A natural rate of inflation would be 3%-5% at the most. Instead, we saw rates of inflation hovering at 30%-40% each year.
Other than low interest rates, what caused the spike was a number of factors such as houses being purchased for short-term investment, subprime lending, interest-only loans, negative amortization loans...etc. Negative amortization loans, by the way, are loans whereby the interest itself isn't even paid down, and it in fact accrues to the principal balance.
Without those factors which eventually brought us to the current predicament, it would be safe to say that an ideal median housing value would be somewhere around 50% of what those homes were selling for at the peak of the boom.
That's a rough estimate, however, and largely depends on the area.
http://forums.pearljam.com/showthread.php?t=272825
People buy shit they can't afford...houses, cars, clothes, eat out all the time. How many people in America have credit card debt? How many people make absolutely shit for money and think they can walk into a 200K home? I knew something was up when coworkers of mine where buying houses left and right in Phoenix AZ where I lived from 2004/2007 The problem was that me and my coworkers made only around 35K a year, and they where buying huge houses. I could barely pay my rent for my apartment and I didn't have a bill to my name, so I know they couldn't afford house by themselves for more than 200K, but they managed to get the home anyway. So I think the problem starts with the American people putting themselves in debt with out any restraints. My ex bought a house about a year ago with an interest only loan, how shitty is that? She hasn't paid into the house yet, just the interest.
That pretty much sums it up, and that just goes to show that this shit is common fucking sense, and that there's no excuse for what's happening right now.
http://forums.pearljam.com/showthread.php?t=272825
It looks like it all comes down to what George Carlin said: People buying shit they don't need with money they don't have.
My question is why would investors purchase derivatives? If they are high risk loans bundled up in a bunch - what is the attraction for an investor? I can understand the banks figuring out a way to sell off their risk - but who would want to buy them? What was the payout to them?
Yes, I've always thought that everybody in America wanted to be the next Robert Kiyosaki (Rich Dad Poor Dad), and that he is ultimately to blame for everything that's happened.
But, what I was also trying to convey in my summation was how the government knowingly created the right conditions for all of this to unfold. The Bush Administration was like a bunch of gamblers at a cock fight, sadistically watching as people destroyed each other and themselves just to own a shitty little piece of property.
In fact, as far back as 2003 I remember e-mailing an old college roommate of mine and calling Alan Greenspan a fucking elitist piece of shit for creating the market conditions that he created.
I appreciate all the thanks I got for my contribution to this thread.
And if you're into the counter-culture conspiracy-theory version of the stated events, then Drifting's post isn't a bad read either.
http://forums.pearljam.com/showthread.php?t=272825
Yield my friend.
It was all about yield.
And just like mortgages are (sadly) too complicated for most average americans to understand, i believe that securitized mortgages were packaged (and presented for purchase) in such as way that even those agreeing to sale were not truly aware of the real risk. Some of it probably had to do with the way they were packaged, some of it probably had to do with the ratings of the rating agencies, and some of it probably had to do with a simple failure of the market to continue appreciating -- i mean, how high were house prices supposed to go?
All of it definately had to do with abnormal interest rates in a managed economy.
But as for Spongers assertion that rates should be higher, the unfortunate problem is that consumers (at all levels, including banks, which are purchasers of rates) are used to, and dependent on, low low rates. I don't despute the accuracy of his claims that rates were too low -- certainly they were. But a violent rise (though possibly inevitable, once the market has its way) in rates is catastrophic after a "bubble" "bursts".
The rising of interest rates now will probably have devastating short term impacts. You simply can't demand a violent contraction after a sharp inflation. We did that once, look it up, its called The Great Depression.
You think the housing market is fucked with a mortgage at 5.5 or 6.0%?
Try 8, 9, or 10% ... lets not even think about 18%. All sellers, no buyers = not fun times.
And that is not even getting in to the whole connodrum of the treasury market in a high interest environment, the problems inherent in a world where banks are stuck in low interest investments, but paying high interests on deposits!
If I opened it now would you not understand?
I'm trying to put this in a way so not to sound elitist, but derivatives are by nature extremely "complicated."
I remember my derivatives professor in college telling the class one day, "No one has really truly figured out derivatives yet."
Think of derivatives as being like the physical embodiment of the controlled chaos that is the stock market.
At any rate, high risk is not without the occasional high return.
If you would like an idea of the nature of the derivatives that were used, here's wikipedia to the rescue.
http://forums.pearljam.com/showthread.php?t=272825
Peace
Dan
"Every judgment teeters on the brink of error. To claim absolute knowledge is to become monstrous. Knowledge is an unending adventure at the edge of uncertainty." - Frank Herbert, Dune, 1965
Again...I'm feeling the love here.
Also, I want to take a moment to note that I have noticed in the past several days other members providing excellent "low-downs" on the events at hand. Namely JOEJOEJOE comes to mind, but that is not to exclude others.
I think the difference is that this thread provided an opportunity to lay down a somewhat definitive account, but not one that should be regarded as authoritative by any means.
http://forums.pearljam.com/showthread.php?t=272825
I find this aspect interesting...that people are selling their houses for much less than what they paid for them. I don't think the market has bottomed out because, as you said, there were 30-40% increases each year, but people aren't marking down their houses that much. I recently talked with my real estate broker who wanted to show me a house - and I told her that I already knew what the person bought it for in 2005, and they think they are still going to make a profit on that inflated price now...no way. It wasn't worth the asking price when the bought it, and it certainly isn't worth that same amount now. Simply because someone paid $500k for a house doesn't mean that it's actually worth that much - that was just how much it was worth to THEM.
Thanks for taking the time to explain this situation, in terms I could understand:D
You and Drifting have been very helpful and informative.
So is it true that this $700 Billion Bail Out Bill contains/contained stipulations that would give Treasury Secretary Henry Paulson full and complete control of the $700 Billion, as well as complete immunity from legal and criminal charges/ramifications for his utilization of the $700 billion and whatever deals/transactions he makes?
Seems like there's a few people claiming this and I'm seeking clarification and confirmation.
no modern day socialist gov't would allow this to happen ...
thank you and have a nice day
That's because America is closer to Facism, than it could ever be to 'Socialism".
I believe that is one of the first stipulations that got thrown out the window.
Thankfully Congress is seemingly the last functioning vestige of our constitutional government, and they actually answer to the will of their constituency.
I have not read the bill (that has now failed), but from everything i was hearing, this provision was removed, along with several other tax payer unfriendly clauses.
My biggest problem with a bailout is not the provisions of it, it is the fundamental concept.
If I opened it now would you not understand?
I may be completely off-base in what I'm about to say, so Sponger or other knowledgeable people correct me if I am wrong.
To me the reasons these derivatives had appeal was due to the spreading of risk. Lending to someone who will have a hard time repaying will require a high interest rate to cover the risk. However, if you take 1,000 such loans, you figure that some people will be able to pay the loan back, and some won't therefore making it less risky than the single loan and in turn requiring a lower interest premium. Apparently, investors thought that this risk spreading was so efficient that these derivatives were at a bargain price.
Investors had not valued in the risk of a housing market bubble burst. Now that this has occured, the values of these derivatives have to be written down which is how all these banks are losing value.
Bridge School '06 Night 1 & 2
Venice '07 pummeled by the sleet!
Nijmegen '07
Werchter '07
April Fools ~ LA1