The Bailout Explained
I was a bit caught up the past two weeks and did not get a chance to write about everything I wanted to, so bear with me as we go through some week-olds. The first, what the heck is this bailout? What will it do? Why did the first one get voted down? What’s the difference between the first and the second plan? And WHY oh why isn’t it working yet?!!
What is this bailout?
The bailout was intended to inject confidence back into the market so that everyone would start trading again. See, much of our market rev up was due to the trading of mortgages, which lost their value and are unable to be sold now. This “bailout” would jumpstart that market again. Or so they hoped. Later, they’d use the $700B to buy up distressed mortgage securities (not the mortgages themselves, but the Mortgage Backed Securities that got us into this mess – remember the ones where they bundle up all of the mortgages and then sell that bundle off like a stock. These are CMOs, CDOs, CDSs, ABSs.).
Why this plan? Interestingly enough, many thought the reason the Great Depression was so great was because the government did not act fast enough. In their book A Monetary History of the United States: 1867-1960, Milton Friedman and Anna Jacobson Schwartz argued the Fed could have mitigated the financial crisis of the 30s by cutting rates, buying bonds, and making loans. Instead, the Fed reduced its credit to the banking system, causing about 1,860 banks to fail. Luckily for us, Bernanke is a Great Depression expert (really, he studied the G.D. intensively.. perhaps they had a bit of foresight when they brought him on in early 2006).
What’s the difference between the first and second plan?
The initial draft was 3 pages. Here’s the initial draft proposal. But many thought the first plan gave Paulson too much power and that the government wasn’t going to get enough ownership stake in the companies so that we, the taxpayers, could benefit if the plan worked.
That got reworked into about 110 pages for Bailout Plan #1. The first plan gave the Secretary of the Treasury (Paulson) the right to buy up any mortgage related assets. It proposed disbursement of the $700 billion in stages. The first $250 billion would be issued when the legislation is enacted while another $100 billion could be spent if the president decided it was needed. The remaining $350 billion would be subject to congressional review. In an attempt to protect taxpayers, the banks selling the assets would issue stock warrants – which gives us an opportunity to take an equity stake and therefore make profits.
But it was voted down on September 29 in the House, 228 to 205. The majority of nay sayers were the House Republicans, but it received nays from both sides.
Back to the drawing board. The Senate then reworked the plan and had a new draft ready October 1. On October 3, the House approved the plan, 263 to 171. What was the difference? The second plan, a 450 pager,saw a few changes – it requires the Treasury to set up an insurance-based alternative. That is, instead of buying up the mortgage securities (MBSs), the Treasury will act as an insurer to the banks holding MBSs and the bank will, in return, pay the Treasury a premium. It also temporarily raises the FDIC insurance limit from $100,000 to $250,000. It also allows for the purchase of MBS’s through a reverse auction, where the banks will compete to sell their assets to the Treasury. The Treasury sets a price (usually a higher one to ensure good participation) and then allows the institutions to offer lower prices. It also allows the Fed to pay interest on the money that banks must leave in the Central Bank – this will hopefully provide some more liquidity into the financial system and to our ailing banks.
It’s also stuffed with what people like to call PORK. $150 BILLION worth of tax provisions for some rather random parties. Here’s the list of recipients:
- Wind Power
- Solar Power
- Disaster Victims
- College Students
- Teachers
- NASCAR Racetrack Owners - $128 million
- Small- to Medium-budget Film and Television Productions - $10 million
- Bicycle Commuters
- Makers of Virgin Islands Rum & Puerto Rican Rum $192 million.
- Owner of Plug-In Electrical Vehicles
- Corporations Operating in American Samoa - $33 million
- Mine Rescuers
- Worsted Wool Fabric Producers
- Alaskan Fisherman whose livelihoods suffered as a result of the 1989 Exxon Valdez oil spill - $223 million
- Makers of Wooden Arrows for Use by Children - $6 million
So with all that The Emergency Economic Stabilization Act aka the Wall Street Bailout Plan was passed by the House 263 to 171 and was signed October 3. Huzzah!
Huzzah? But it’s not even working!
No, it’s not working. At least the confidence part, since the actual implementation of the plan hasn’t begun yet. Despite all the attempts at assuaging our fears, fear levels among investors are high, fear levels among the banks are high, since they’re not lending each other money as they usually do, and fear levels among the rest of us are high. And it’s showing in the market.
