Wednesday, October 08, 2008

Flip this one off

Let's see if I got this straight. Let's say I'm a bank (ok, you're a bank), and I loaned a million dollars to people to buy some houses. Now on my books, I say I'm worth 2 million dollars, because when everybody pays me back with interest, I'll be worth that much. So since I'm worth more money, I can loan out even more money, so I do. Now I realize that those people aren't going to pay me back, and I have to foreclose on them, and suddenly on the books, I don't have all that money I said I did. Uh oh, financial crisis. Along comes the Government who wants to bail me out. But first, before the house will agree to bail me out, they first want to make sure I get some tax cuts, and they do. So now the Government is going to buy my bad loans so I can take them off my books. So apparantly, the people who I foreclosed on are now houseless, and owe the Government the money. I've been paid. I still have the house because I foreclosed on it. I got the tax breaks. This is a great country. And here's the real kicker. Let's say I owned the houses that I loaned the money for in the first place. That would mean I loaned somebody money who then gave it to me, but then couldn't pay me, so I took back the house and the government gave me the money, but only after they made sure I got a tax break. This is a really great country.

Two middle fingers up to the bailout.

4 Comments:

Blogger hucktunes said...

I got emails from both Senator Feinstein and and Mike Thompson explaining why they signed the bill. Neither mentioned how much money they would have lost if the bill had failed to pass. Both did mention what a good deal it is to have deposits insured for $250,000 rather than $100,000. Flip 'em off for me too, Jeff.

8:29 AM  
Blogger Nicholas Karavatos said...

Jeff,

Christine forwarded this email to me:

A friend of ours wasn't quite able to get a grasp on the current financial crisis and bail out plan that is going on here and asked me for an somewhat simplified explanation. Since I wrote it out, I thought you might be interested. You may find I haven't simplified it at all...or you might just not be interested, but just in case, I'm forwarding my response. If you do decide to read it, get ready to be afraid. Just so you don't get confused right off, her husband is a cabinet maker named Kerry, and their children are Jenny, Austin and Mitchell. I used their personal situation to help clarify the drama for her. Here goes:

In response to your question, my take on it is that it is really scary, and I don’t think that that the government has done a very good job of explaining the situation to the American people, or even to congress. Here’s the situation as I understand it:

America runs on credit, and there isn’t any. In your particular situation, Marriott Hotels decides that they want to fix up their hotels by installing new cabinetry. Normally, they would get a loan, hire Kerry, Kerry would make cabinets. Now, they cannot get a loan, so no refurbishing, Kerry doesn’t get hired, he doesn’t have enough money to run his shop, has to let Austin and Mitchell go, Austin can’t pay the mortgage on his land, the bank forecloses. This is the process with food and clothing stores who use loans to buy product to put on their shelves, automakers, Fed Ex, lumber companies, student loan companies, virtually all businesses that you can think of. If they can’t buy product on credit, they have nothing to sell, business dies, people get fired and can’t pay their bills. That’s why Hank Paulson says it’s not a Wall Street problem, it’s a Main Street problem.

It’s not fair for those of us who managed our money responsibly, but it will hurt all of us one way or another. Bailing out the financial system at this point will be painful, but not as painful as if we don’t. To give you another little personal picture of this, it’s like if Jenny burned down your house and workshop, and the rest of your family refused to rebuild it because they weren’t responsible. Everyone can sit around demanding that Jenny take responsibility to rebuild, but the fact is that winter’s coming and you’re all going to get very cold out in your tent, and very hungry not being able to work to pay the bills. Sooner or later, you’re all going to have to suck it up and start hammering.

Now, the reason the big companies can’t get loans to keep business running. Banks get money from three main sources: 1. Interest on loans 2. Loans from each other 3. Deposits. At this point, number one is out of the picture because so many people are defaulting. Number two is also out because healthy banks are unwilling to loan to any other banks because they don’t know if the other banks are healthy enough to pay the loans back. This is because banks have not been required to reveal their financial situations and the level of mortgage defaults. All of the banks that have gone into bankruptcy or had to be bought by others or suddenly gone in search of money from outside sources claimed to be healthy until the day they were taken over. This is why the government has repeatedly stepped in and increased the amount of money banks can borrow from it--no one else trusts enough to loan money. In addition, as people in general hear more andmore about these problems, they have begun to take their own money out of the banks and take it home to hide under the mattress--this is number three, deposits are disappearing. This is what happened in the Great Depression. In response to that (the bank run of the Great Depression), the government set up FDIC (Federal Deposit Insurance) which insured that the government would guarantee to pay people up to $100,000 of the money that people had in any bank that failed. There are three problems with this now. 1. Until last week, the FDIC did not cover money market accounts 2. People have more money now and $100,000 is not enough to cover it. This can be fixed by spreading their money out across several banks, $100,000 in each (confusing to keep track of if you have millions) 3. The FDIC only has something like 50 billion in reserve to cover these accounts, and the American people have something like 7 trillion is savings.

So there’s the basic background. The idea of the 700 billion bailout that they tried to pass Monday is that the government will take all the banks’ bad debt. This will make all banks healthy and the overall financial industry will then not be afraid to loan money. The hope is that things will start opening up again, Marriott hotels will be able to get a loan to refurbish, they will hire Kerry, he will be able to go to the lumber yard which will have bought product on credit, the cabinet making business will continue booming, Austin and Mitchell will keep their jobs, everyone will be able to go to Kroger and buy food, which Kroger will have because they were able to buy it on credit and the trucking companies were able to bring it on credit, house payments will continue, credit cards bills will be paid. In addition, since the government doesn’t have to worry about frantically selling any of the assets they take from the banks, they can hold on to them until things calm down. This may well allow the government to sell assets at a decent price, which means the government would actually make a profit in the long run. Not a guarantee, of course.

I don’t know if the bailout package that Congress voted against on Monday was a great solution, but it was generally felt to be the best people had been able to come up with. In my opinion, Congress did the worst thing possible when they brought it to a vote without the ability to pass it. This just created more fear. They should have kept working on it until they were able to come up with something they could get the votes for. The news was putting the blame on the Republicans last night, but the truth is that both sides need to stand up and take responsibility both for allowing this situation to occur and to deal with it. A large number of Republicans voted against the plan, but the truth is that the Democrats are in the majority and could have passed it on their own. I feel myself on the verge of veering off onto thoughts on presidential candidates at this point so I will just pull myself back to the topic at hand and say that Congress and the Fed are now working on other ideas to get something passed before the stock market crashes out of fear and the economy in general comes to a screeching halt for lack of credit. One thing I have heard mentioned several times is the idea of raising the FDIC to $250,000 so that people with more than $100,000 won’t continue panicking and withdrawing money from the banks. This sounds like a fantastic and easy idea at first…until you go back a couple of paragraphs to where I pointed out that FDIC is underfunded to deal with even $100,000. However, as many people are not aware of this, the plan would probably be effective in calming things down.

I mentioned in a previous e-mail that Patrick had called our congresswoman. This was because one aspect of the proposed bailout was to bail out foreign banks with holdings in the U.S. I am not against everyone sharing and playing nice together; however, the more the U.S. goes into debt with this (or realistically just increases the money supply by revving up the printing presses), the less the dollar will be worth. Better for these foreign countries to bail out their own banks and have their money drop in value as well.

The really bad news is that even if this works for the credit markets, we still have tons of people defaulting on their mortgages and credit card bills and auto loans…. This bail out will in no way address these issues, BUT it might keep these issues from getting much, much worse. Perhaps a long recession rather than a lengthy depression. We can already see the dominos beginning to fall in other countries, so this will be global despite what many have said in the past year or so about a global disconnect.

There are many more pieces to this that basically make me want to just throw up, but this seems like a good start. Hope it wasn’t either too basic or too complicated. Let me know if you have questions.

10:11 AM  
Blogger hucktunes said...

The bail out will not jump start the economy. All it does is relieve those responsible for the bad loans of liability and keep the corrupt FED in business for another year or two. It would have been much cheaper to help out those who had lost their homes and pensions because of the junk bond and hedge fund trading and perhaps throw in some health care for good measure. Property values are artificially inflated because the cost has been driven up by the easy credit. These bad loans were sold as hedge funds and now the true value is apparent and can no longer be resold. So the bail bought these bad loans from the Wall Street traders. Simple as that. It will have no effect on the economy. Supply and demand is still the rule. Marriott's can still hire contractors and build a new unit.

10:01 AM  
Blogger Several People said...

Wow, I didn't even notice there were comments here. Nice job Nick.

12:51 PM  

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