Friday, Sept 26th - Zero: The Bailout

I found some great information on the bailout proposal by going to John Boozman's website. If you are interested, please read this information.

If not - just know this: The bailout is listed at $700 billion. This is on top of $900 billion we have already spent on the bank crises (Bear Stearns, AIG, Freddie and Fanny). Already, that represents $5,666 per person in the United States.

However, you add that number to the current national defecit the number goes up to 53 TRILLION dollars. That is $176,666 per person in total tax burden. Now, since we know that a full 40% of the population pays NO taxes, that means that those of us that do, are stuck with $294,444 each.

Chew on that for a while.

Taxpayer dollars shouldn’t be used to subsidize salaries of executives who have made bad business decisions. We can’t allow company officials to who break consumer confidence and send businesses into turmoil to benefit from bad practices. We owe it to the American people to make these officials accountable for their actions.

This is not the time for hurried legislation. We need a well thought-out approach to solving the problems we are facing. Washington should not be rushed into making such a critical decision that impacts the American economy. Sure, we need to protect the credit system in this country, but not by killing the American taxpayers!

A BACKGROUND ON RECENT BAILOUTS

Until this year, the federal government has never injected so much money into the U.S. financial market since the Great Depression. In addition to using interest rate adjustments to address the looming financial situation, the Federal Reserve and the U.S. Treasury have stepped in to “bail out” large financial institutions that were nearing bankruptcy or facing grave financial distress. The bailouts have raised questions over whether the federal government has a role in staving off consequences of bad business decisions to protect further losses in the market, and whether the economic crisis today is of such grand proportion that it would warrant the federal government to step in on the free market economy.

The following provides a breakdown of each bailout that has occurred this year, and the situations leading up to each bailout.

Fannie Mae and Freddie Mac are Government Sponsored Enterprises (GSEs), or privately owned, Congressional chartered financial institutions created for public policy purposes. They were created to increase liquidity and improve distribution of capital available for home mortgage financing. As GSEs, the charters of Fannie Mae and Freddie Mac limit them to purchasing single family and multifamily home mortgages. As a result, they lack diversification in the types of mortgages they buy which makes them more susceptible to problems and fluctuations in the home mortgage market.

According to a report by the Heritage Foundation, experts have warned for decades that both Fannie Mae and Freddie Mac lacked sufficient capital to protect against losses. While most banks have $1 of capital for every $12 in assets, Fannie Mae and Freddie Mac only have $1 for every $20 in assets. Fannie Mae and Freddie Mac hold about 70 percent of the national market share of home mortgages, and they both guarantee mortgages and hold about $5 trillion worth of them in their investment
portfolios. Beginning in 2004, their portfolios began to grow primarily with subprime and alternative-A loans. From 2003 to 2006, subprime and alternative-A originations in the U.S. rose from less than 8% of all mortgages to over 20%.

Between the end of 2007 and August 2008, Fannie Mae's stock lost 72 percent of its value and Freddie Mac lost 77 percent of its values, which many attributed to improper accounting practices and homeowners falling behind on subprime mortgages, putting 70 percent of the home mortgage market share at risk.

On July 30, the President signed into law H.R. 3221, a $800 billion housing aid bill to rescue Fannie Mae and Freddie Mac. On September 7, the U.S. Treasury announced the federal government seized control of Fannie Mae and Freddie Mac, arguing if the crisis had continued, lack of cash would have made it more difficult for consumers to obtain home loans.

Cost of the Bailout: $800 Billion

Congressional approval was sought for this bailout. Congressman Boozman did not support the bailout.

Bear Stearns:

At the beginning of the year, Bear Stearns was the nation's fifth largest investment bank. When the housing market took off earlier in the decade, Bear Stearns became actively involved in the residential mortgage market. As a result, it held a large amount of mortgage-backed securities. When the housing market plunged, Bear Stearns began to experience financial trouble. In response, Bear Stearns poured more money into subprime mortgage funds. When the housing market continued to decline, Bear Stearns found itself in an even deeper financial struggle. In March 2008, it was virtually crippled by a liquidity squeeze related to devalued mortgage-backed securities and neared bankruptcy.

In response, the Federal Reserve System announced on March 14 that it would provide a short-term loan to help Bear Stearns. Two days later, JP Morgan Chase, a commercial bank, agreed to buy Bear Stearns, and the Federal Reserve agreed to provide special financing to help with the transaction for up to $30 billion of Bear Stearns’ less liquid assets. After additional negotiations between Bear Stearns and JP Morgan Chase, the transaction ended with the Federal Reserve agreeing to finance $29 billion of Bear Stearns’ less liquid assets. Before this point, the Federal Reserve had never "bailed out" a financial institution that was not a commercial bank.

Cost of the Bailout: $29 Billion

No Congressional approval was sought for this bailout.


Lehman Brothers:

Lehman Brothers is a global financial services firm who, like Bear Stearns, held a large share of mortgage backed securities. When the subprime mortgage market took a hit,the Lehman Brothers faced substantial losses just as Bear Stearns did. In the first half of 2008 alone, Lehman's stock lost 73% of its value.

On September 14, Lehman brothers announced that it would file for bankruptcy protection, subsequently sending the stock market down 500 points on September 15, the largest drop in a single day since the terrorist attacks of September 11, 2001. Lehman Brothers sought government intervention to no avail. On September 16, Barclays PLC acquired a portion of Lehman brothers and no government bailout was instituted.

Cost of Bailout: None. No government bailout occurred.

AIG:

After Lehman Brothers, investors began looking at national insurance company American International Group’s (AIG) securities and found that they were similar to Lehman Brothers’. AIG’s credit rating was downgraded and it suffered a liquidity crisis because it could no longer access capital. As such, AIG's share prices fell 95% on September 16. At AIG's request, the Federal Reserve loaned money of up to $85 billion to AIG to prevent its collapse, in exchange for a 79.9% equity stake in the company because there was concern that many U.S. banks would fail if AIG did not keep operating.

Cost of the Bailout: $85 Billion

No Congressional approval was sought for this bailout.


THE PROPOSED WALL STREET BAILOUT BILL(The Paulson Plan)

The U.S. Treasury Secretary Henry Paulson is asking for authority from Congress to buy the troubled assets from financial firms that are said to be causing the current financial crisis. Secretary Paulson is asking for $700 billion to buy primarily mortgage-related debt, which will allow financial institutions to raise capital and begin lending and investing again, resulting in a theoretical “jump start” of the economy. The plan is for the government to hold the assets until the market can recover. It then would sell the assets back into the market through a “reverse auction,” where the government sets a minimum price for the asset and financial institutions bid on the asset for purchase.

The proposal is now being considered on Capitol Hill where some lawmakers and interest groups are pushing for additional provisions to allow bankruptcy judges to modify mortgage terms, adding terms to provide plan oversight and market regulation, and provisions to curb executive compensation in companies that participate in the bailout.

Leadership in Congress has suggested that the proposal is likely to be voted on this week.

Who is going to come up with the $700 billion?

American taxpayers will shoulder the cost of the bailout, which could actually be anywhere from $500 billion to $1 trillion, depending on how the assets are priced and how many are sold. The Treasury will attempt to resell them to investors, which some argue could result in profit and, ultimately, a lower price tag. There is no assurance of this profit, however, and many argue that the government is at risk of losing a great deal of taxpayer dollars through the purchase of this mortgage debt. In order to finance this plan, the Treasury will need to borrow money to buy the assets. It has asked for an increase in the debt ceiling, which means we must increase the federal deficit for the second time this year and increase interest payments on our federal debt. In addition, the $700 billion will be on top of the $900 billion tax dollars that have already been obligated for Bear Stearns, Fannie Mae, Freddie Mac, and AIG.

How long will the government hold these assets?

Ideally, the government should hold assets for the shortest amount of time possible. However, in reality they could end up holding them until maturity. For example, the government could hold a 30-year mortgage for the entire 30 years, or they could sell it at its discretion. With respect to the reverse auction, the number one priority should be to maximize the price for the American taxpayer. While the government may hold these assets at their discretion, the current Paulson plan would allow the government to purchase these assets for only two years.

What is the rationale for acting now?

According to a Congressional Research Service report, a press release from the Treasury stated illiquid mortgage-related assets had clogged the financial system. The combination of the government’s refusal to intervene on behalf of Lehman Brothers the same week that a bridge loan was extended to AIG has led many to believe that a case-by-case approach needs to be replaced with broad intervention. In addition, the sudden spike in interest rate spreads and declines in financial activity following the AIG intervention caused some policymakers to believe that the fragile financial market could worsen if it were not addressed. On the other hand, many argue that while addressing disruptions in the market as soon as possible is preferable, the urgency to address the situation immediately is caused in part by issues unrelated to the financial markets such as congressional schedules and political elections.


Arguments for the Bailout

Proponents for the Wall Street bailout are concerned that the financial crisis is starting to impact historically safe assets like money market accounts, and that retirement savings and investments of middle class Americans may be at risk. While these “safe” assets have no direct reason to suffer financial distress, they may suffer due to lack of market confidence. When this sort of market panic has developed, proponents say the federal government has an important role in calming the markets. As such, Secretary Paulson has created a plan to restore confidence in the financial market, which the Administration argues would address financial market distress and would preserve an individual’s capacity to borrow money to buy a home or to finance a college loan or allow small businesses to obtain credit. Without this government intervention, he argues, we would experience dire economic conditions – tax dollars would provide insurance against economic disaster.


Arguments Against the Bailout


Opponents of the bailout plan argue that buying troubled debt provides the most help to firms who have made the worst investments. According to Douglas W. Elmandorf, Senior Fellow at the Brookings Institute, banks which made responsible decisions to stay clear of bad debt or cut their losses would receive little or no gain from the bailout. Banks with the weakest balance sheet will reap the best rewards. Opponents of the plan argue that this will undermine an important financial principle that companies which have failed should have a smaller role in the market and it sends companies the signal that the government will be there to bail them out when they make bad business decisions. Under this assumption, opponents question what incentive businesses would have to take steps to ensure their own survival, such as voluntarily renegotiating troubled loans. This type of action could put the U.S. on a dangerous and unsustainable path where fundamental market principles gradually disappear to an economy in which the federal government owns significant assets and controls liquidity.

In addition, the bailout is a big risk for taxpayers with little gain. Because the amount the Treasury will use to buy assets must be borrowed, it will raise the federal deficit. This liability, on top of other long-term liabilities for Social Security, Medicare, and Medicaid, means American taxpayers could be liable for more than $53 trillion, or $455,000 per household in federal debt.


Opponents also argue that much of the problem we now see has been the result of too much, rather than too little, government intervention. They say the current crisis is an example of what happens when politicians - Republicans and Democrats alike - enact policies in order to score political points or as knee-jerk reactions to perceived or real crisis without regard for the possible consequences and foresight as to future implications. Policies legislated in the past that have encouraged or even mandated lending to low-income and under-qualified borrowers may have made for a good sound bite, but they forced private businesses to enter into risky and unwise transactions that they otherwise may not have considered.


Sorry it was so long - but now you can't say you weren't informed!

Peace, Love, and GOD,
Tracy