Are people confused about what the bailout means? ?

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Although the source of the problem came from Wall Street and poor mortgage decisions by unqualified home buyers, it now a American public problem. It has an adverse effect on EVERYONE.

The problem is that banks are unwilling to lend money to businesses because they need to keep liquid cash on their books to remain solvent due to the bad mortgages they are holding. When banks are reluctant to lend money, small businesses who often use short-term loans to make payroll, research & design, market, transport, etc. cannot get the funds they need to stay in business. As this occurs, jobs are eliminated and/or these businesses fail completely raising the unemployment rate and overall economic hardship for everyone. Anyone looking to punish Wall Street is misguided because only the behemoth corporations will be able to get the bridge loans needed to keep going. They will survive, it is the average small business owner (who creates the vast majority of US jobs) that will be hurt the worst.

Also, interest rates for new mortgages to qualified borrowers will go up, further pushing the housing market down and creating even more defaulted mortgages. A snowball effect occurs and credit markets get even tighter and more businesses fail.

Unemployment will be rising, while the number of new jobs for the unemployed to fill will be getting smaller. As unemployment continues to rise, households will be left without incomes and begin to default on other lines of credit such as car loans and credit cards. Again, the snowball continues.

Since disposable income will decrease because of the unemployment numbers, the economy will continue to suffer because people will start to hoard cash instead of fueling the economy with spending. More businesses will fail, and so on.

People not in the work force with retirement savings will find their portfolio values decimated, perhaps postponing retirement or making it impossible altogether. Again, creating an influx of people into the job market where there are no jobs available.

Anyone in Main Street USA who does not believe this will not affect them are naive. the Wall Street you are mad at has already failed and has been restructured. Get over it.
The bill includes: Periodic payments, not a $ 700 lump sum. Congressional oversight of the Treasuries’ actions. A bump of FDIC from $ 100,000 to $ 250,000. Elimination of golden parachutes. Taxpayer equity (ownership) in participating companies with preferential debt recovery/profit going the taxpayer vice shareholders. A tentative timeline for government removal from the market.

Myths: Its a blank check, there is no oversight/puts one man in charge, etc., credit is not important to the US economy and veryone should pay cash. Wall Street will be the only one to suffer. It will pay irresponsible homeowners’ mortgages. It doesn’t help the average American. Government involvement harms the free market (history has shown that government is sometimes necessary. ie the Great Depression).
Also included: An insurance option to back the questionable securities giving them marketability and more easily obtained market value.
Keep in mind, there is a consensus that tighter regulation must be passed, but due to time sensitivity it will be addressed at length after the bailout.

I have written about the great imbalances of the US economy. Yet in all of my previous articles on the subject I have been unable to pinpoint when these imbalances will result in a bust.

One can never be completely sure of the future, of course, as one does not have full information about all factors shaping future events. Thus, it is possible that this prediction will go wrong if the US experiences some future positive shock, such as for example a significant decline in oil prices. Australia seemed poised for a recession in 2005 after its housing market busted, but this was averted as the prices of Australia’s commodity exports soared because of increased demand from China.

However, barring such an unexpected positive shock, it seems increasingly clear that we will see a US recession this year. The main reason for this is that the housing bubble that fueled the recovery of the last few years has essentially burst.

While mortgage debt continues to climb, albeit at a slower rate than before, and while housing prices have flattened rather than declined so far, other housing market indicators point to a housing recession. New home sales have reached multi-year lows and the inventory of unsold homes reached multi-year highs. Meanwhile, residential investment has declined significantly from its peak in late 2005. From 6.3% of GDP in the third quarter of 2005 to 5.3% in the fourth quarter of 2006. However, that is still above the 4% average of the 1980s and 1990s, and also significantly above the 3.3–3.4% level of the recessions of 1982 and 1991.[1]
So far, the economy has seemingly handled this fairly well and experienced what one might call a “soft landing,” with growth being slow but still well above zero. Yet there are increasing signs that the worst is yet to come. Much of the housing bubble was financed by so-called subprime mortgages, mortgages to people with a low credit rating. Subprime mortgages were encouraged greatly by the government, with the Federal Reserve providing a cheap source of credit and with Bush encouraging it as part of the “ownership society” that he envisioned. But after the Fed was forced to raise interest rates again, and as the introductory teaser offers expired, the cost of borrowing for the subprime borrowers increased sharply. And as subprime lenders almost by definition have weak personal finances, many have proven unable to handle that.
And so we now see how the default rate has increased sharply. This will mean two things: first, new subprime loans will decline sharply. So far this year, subprime loans have declined 37% from last year.[2]
This will not only mean lower demand for new houses, but also increased supply as an increasing number of subprime borrowers are forced to leave their homes. This fact, as well as the fact that construction spending is still at historically high levels means that it is likely to decline a lot more. And if this causes outright decline in housing prices, it will have a very adverse effect on consumer spending. The household savings rate was -1.2% in January and February.[3] Meanwhile, despite record high asset valuation, the household debt to asset ratio reached record levels last year, as did the mortgage debt to housing value which hit a record high of 47% in the fourth quarter of 2006.[4] Looking beyond the aggregate number, you can see that 27% of all homeowners have less than 20% equity (more than 80% mortgage debt) in their homes and 16% have less than 10% equity, making them highly vulnerable to a fall in prices.[5]
All of this implies that the current spending pattern is dependent upon a continued rapid increase in asset prices, from levels which are historically already extremely high. Household real estate values, which in my first article on the subject I reported to be 184% of disposable income, up from the historic range of 135% to 150%, had in the fourth quarter of 2006 risen to 213% of disposable income. Meaning that there is certainly a high risk of falling prices — which, given the negative savings rate and the record high level of household debt, would imply that consumer spending will have to fall.
With residential investments likely to continue to fall and with consumer spending likely to be weak as well, the one thing that could save the US economy would be business investments. Business investments are still at a relatively moderate level, and in relation to corporate profits they are in fact historically low.
However, there are signs that corporate profits have peaked. The increase in profits over the latest year has been concentrated in the financial sector and in foreign subsidiaries of US firms. In contrast, profits at domestic non-financial industries (the sector that invests) have started to decline: in seasonally adjusted terms, they were 2.5% lower in the fourth quarter of 2006 than in the first quarter.[6] And with profits showing signs of declining, it is perhaps less important that they are still at high levels in absolute terms, because what matters for business leaders is not so much current profits, but expected future profits — or to be more precise, if businesses think additional investments will generate even higher profits.

And with the pessimism generated by the decline in profits and the trouble in the housing market, an increasing number of business leaders seem to think that the days of high profits will be over soon. Business investments fell during the fourth quarter of 2006, and judging by the weak data for non-defense, non-aircraft durable goods orders,[7] the outlook for 2007 is not particularly good.

But what about the Federal Reserve? The Fed has always been “the knight in shining armor” always saving the day by cutting interest rates — and they will do so again. At least, that’s what many people on Wall Street seem to think. And of course, Ben Bernanke would certainly be willing to provide “liquidity” — with or without helicopters — if he thought a recession was coming.

However, the fact that commodity prices continue to soar and the dollar is falling means that Bernanke will have limited scope to cut interest rates, particularly in the aggressive way that Greenspan did after the tech stock bubble burst. With businesses being reluctant to invest, and with subprime mortgages discredited, one has to wonder: where is Bernanke going to create the next bubble, the one that will mask the hangover from the housing bubble in the same way that the housing bubble masked the hangover from the tech stock bubble?

  1. Reply
    February 6, 2011 at 5:37 am

    Not so much confused as uninterested in any facts that may oppose their dogged view that they will not accept any solution that costs them money. The fact that it is costing them right now, they refuse to believe. They will not tolerate anything that disrupts their rapacious appetite for more and still more. They refuse to be evicted from their fairytale existence.

  2. Reply
    February 6, 2011 at 6:04 am

    Although I do understand the nature of the bail out and it’s importance, as written the legislation would not have the desired effect of maintaining balance.

    The recently rejected legislation gave approval for the treasury to hold 700 billion dollars worth of asset at any given time. This would give th treasury department the ability to prop up certain industry, ignore other and sell of private concerns for pennies on the dollar, all at the cost of the tax payer.

    Basically you are giving the government a blank check to get involved int he market. This will allow for widespread corruption, as it is understandable the preference would be given to companies which the governemnt has an interest in. Likewise the false market will only stand to devalue to the dollar.

    No matter which way you look at it we are screwed. IN the short term the bail out will help, in the long term we will suffer. Or we suffer in the short term and make it up in the long.

  3. Reply
    smellyfoot ™
    February 6, 2011 at 6:49 am

    Right – so banks, although they are sitting on piles of cash, are too scared to lend. And to fix that, we are going to give them more money? Why not just back the securities with insurance? Instead of buying “worthless” assets, why not just back the ones that actually prove worthless? Why not up the FDIC insurance on accounts from $ 100k?

    There are many things that can be done to solve the “credit crunch” that do not require $ 700 billion of tax payer money.

    The bill also elevated the powers of an unelected official way to high for my comfort zone.

    EDIT – is this the Senate bill? It’s some 400 pages long, so I haven’t gotten the chance to read it….But I know the House bill only ended the “golden parachute” for NEW executives. The current ones could still take their parachute ride out – was this issue addressed in the new bill?

    And it can be argued that government intervention helped to prolong the effects of the Great Depression.

  4. Reply
    February 6, 2011 at 7:04 am

    That isnt the problem. I understand the problem perfectly and how this money would help. The truth of the matter is though that credit isnt the big problem, its over use of credit. Private markets got themselves into this mess by doing the very thing the government is trying to get them to do again. What we need to see IS tighter lending standards. On top of all this, home prices are massively inflated. The market is correcting this situation. Considering the lowered cost of home building (cheaper, stronger materials, better equipment etc), homes cost twice what they should compared to the change in average income since the 1950’s. In many areas, homes stand to lose 50% of their value or close to before they even reach the cost/income ratio they had 50 years ago.

    700 billion dollars is only ~120 billion less than Wachovia had in all its deposits, and is almost half of what the government takes in for a year. This is easily enough money for the government to form its own bank and start lending, hire the best employees laid off from behr, lehmen, etc, let the market take care of home prices, and let the banks fall just like they should in a capitalist leaning country.

    Also this recession is only the beginning of a much broader trend. Our economy has a TON of baggage in the form of a whole bunch of people with useless college degrees who demand to get paid more for never producing a single thing. The basis of any real economy has to be food, raw materials, construction, and manufacturing and we have lost a ton of those jobs in favor of service jobs. Now we are seeing the Chinese and Indians beginning to compete in these areas and I will say right now, we are no more intelligent (actually less so by IQ) and soon will not really have any advantage in these fields which means a lot of people who are sitting in offices monitoring sales trends and crunching data will have to move into one of the aforementioned industries. Maybe not for awhile mind you, but sometime in the next 20 or 30 years.

  5. Reply
    February 6, 2011 at 7:50 am

    I would like to answer your question as a small business owner and as a taxpayer.

    “Although the source of the problem came from Wall Street and poor mortgage decisions by unqualified home buyers, it now a American public problem. It has an adverse effect on EVERYONE.”

    That is correct. Unfortunately, most suffer because most borrow without true value to secure a loan. We are going to go our separate ways on this issue–the essence of “real value” and why it is so important to understand that the bailout will do vast harm by creating more debt float.

    “The problem is that banks are unwilling to lend money to businesses because they need to keep liquid cash on their books to remain solvent due to the bad mortgages they are holding.”

    Here I disagree. I had no problem getting a short-term $ 30,000 loan to cover start-up costs for a project I started today. Why didn’t I have any problems? Because I started my business the right way: Instead of using debt to float it, I decided to grow it at a perfect pace until I accumulated real assets to back my loan. I guaranteed it myself, putting up the collateral that I chose to save. I did not demand that taxpayers float my business. The bank likes me. I could have gone the SBA way, but I felt that unsecured, taxpayer-backed loans are only an incentive to be reckless. I’ve seen small businesses go under and not pay the SBA-backed loans. They were poorly managed.

    “When banks are reluctant to lend money, small businesses who often use short-term loans to make payroll, research & design, market, transport, etc. cannot get the funds they need to stay in business. As this occurs, jobs are eliminated and/or these businesses fail completely raising the unemployment rate and overall economic hardship for everyone.”

    Small businesses relying on debt float are ticking time bombs. A lot are on SBA and don’t add any real value. They accumulate nothing. They don’t plan, thus they don’t profit. They will eventually fail. High debt-to-asset ratios are losers. We small business poeple who put up real value for loans and guarantee them ourselves without accounting gimmicks don’t like them because they cause the most job losses.

    An honest business is the best business. Honesty is not a matter of good intentions unless those intentions are backed by a person’s diligence as shown in value exchanges.

  6. Reply
    February 6, 2011 at 8:17 am

    Ron Paul recently said that with all the borrowing we are doing from China, and the constant printing of money we don’t have from the Federal Reserve we have to go into a recession. When countries start to realize our dollar really isn’t worth anything it is destined to happen.

    WHat do we do? Well I don’t think Bush is smart enough to get us out of this one.

  7. Reply
    February 6, 2011 at 8:47 am

    Dang man! You make some really good points. It is scary. However with oil going down the tubes, technology and the development of alternative forms of energy come to mind. Most of our problems have come from money grubbing government and businesses all making the wrong decisions for the wrong reasons. JMHO

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