Last time,we talked about how we got into this financial
crisis – (link to yesterday’s editorial) today, let’s take a look at what our
Federal Government is doing (or not doing) about it.
Almost two weeks ago Henry Paulson – the current Secretary
of the Treasury (a cabinet position – appointed by George W. Bush) proposed a
bill that would give the Treasury 700
Billion dollars to lift Wall Street out of the gridlock it’s been in of late. Since the plan was introduced, The White
house, the Treasury, and Congress have been fighting tooth and nail to hammer out the details of the proposal. On Monday, the proposal finally came to a
vote… and failed. Subsequently, we saw
the largest drop in the Dow in history. Most Americans aren’t sure whether they
should be happy the “bailout bill” failed, or worried about what the failure
means to our financial markets. How
about we – as the Hip-Hop Nation – look at all angles and figure out our own
opinions.
So we all got to the same page previously in understanding
that the root of the problem is the massive amount of foreclosures that are,
in large part, caused by the packaging home loans into Collateralized Debt
Obligations (CDO’s). As people began to
foreclose, the value of those CDO’s began to fall dramatically to the point
where they were almost worthless. Banks,
Investment Banks and Hedge Funds who were heavily invested in these CDOs lost
billions of dollars – their stock prices and value subsequently falling. As they fell, banks – fearing the worst –
began holding on to more of their cash. In doing so the country’s
economic system screeched to a grinding halt. When banks begin losing value, and investors
lose confidence, they begin charging more interest to lend money to each other,
and to American businesses, and eventually they stop lending all together.
Millions of Americans are employed by small,
medium, and large businesses that rely on loans – from these Wall Street Banks
– to meet their everyday operating expenses. Take, for example a company like
Caterpillar (the company that makes all those tractors and lawn
mowers). Two weeks ago they could borrow
money to cover operating expenses at 3%.
This week they’re paying close to 8%.
That may not seem like a big jump, but when you’re talking about a
medium sized company employing thousands of people, you’re talking
about a difference of millions of dollars.
If it becomes too expensive for them to borrow, they can’t make
payroll. If they can’t make payroll –
they go out of business and all those jobs are lost.
Seeing this begin to happen, Treasury Secretary Paulson,
with the backing of President Bush, proposed a plan to take 700 Billion Dollars
of tax payer money and use it to buy the toxic CDOs that are bogging down these
Wall Street firms. That, essentially, is
the bailout plan – 700 Billion Dollars, to be used at the discretion of the Treasury
to buy CDOs. Central to the theory that
this is a good idea are two principles:
We
can’t let these institutions fail because in doing so; we jeopardize
thousands of business that rely on them everyday for loans, which in turn,
jeopardizes millions of American jobs.These
CDOs are worth more then their current market value.
We already discussed the relationship between the Wall
Street banks and the businesses that employ most Americans
– now, let’s look at the other important piece of this plan – valuing Collateralized
Debt Obligations.
The theory that these CDOs are worth more than their current
value has everything to do with stopping foreclosures. Every time someone goes into foreclosure the
value of some CDO at some Wall Street bank or fund takes a hit. Right now, no one on Wall Street knows when
the foreclosures are going to stop and because of that, the Market price for
these securities linked to home loans is next to nothing. When the foreclosures
stop however, the value of the CDO’s may increase tremendously.
Think of it this way:
Say you have a CDO that consists of 100 thirty-year
mortgages. So far, since housing prices
started decreasing about 14 months ago, 5 out of those 100 homes attached to
those mortgages have gone into foreclosure.
That CDO has then lost 5% of its value.
That’s where we are right now. We
don’t know whether 5, 10, 15, or even 20 more homes out of that 100 are going
to go into foreclosure – and because we don’t know that, we don’t know how to
value that CDO. The goal of the Treasury
is plan is to use tax payer money to buy that CDO for below it’s current market
value, stop the foreclosures in it, then sell it back to Wall Street – as a
stable entity – for a nice profit.
This is where the haggling began between Treasury Secretary
Henry Paulson, President Bush, Democratic Congressmen, Republican Congressmen,
Barack Obama and John McCain.
Let’s go through each side of the debate and try and
understand what they’re fighting for.
Henry Paulson and George Bush
Paulson and Bush are the architects of this plan (really,
just Paulson). It should be noted that
Paulson is the former HNIC of The (former)Investment Bank – Goldman Sachs, he
left Goldman to become Treasury Secretary for Bush in 2007 – His package upon
leaving… over 160 Million dollars. Both
Paulson and Bush seem to be, in this case, primarily concerned with doing
whatever they can to pass this proposal to prevent the bleeding on Wall Street
from trickling further in the lives of average Americans. They believe the country is on the brink of
disaster, and that this is the best way to avert that disaster.
Democratic Congressmen
The Democrats in Congress primary concern is making sure
that this bailout plan doesn’t come off as if the government is rewarding Wall
Street its failures. They want to limit
the power of Secretary Paulson in overseeing the plan; his original proposal,
called for him to have sole authority over how the $700 Billion is spent,
without any oversight by congress or any court in the nation. Democrats also wanted to limit the
compensation of Wall Street executives make use of the plan by getting rid of
their companies bad CDOs. Again, they
don’t want folks to be rewarded for failure.
Most importantly, Democrats wanted the ability to re-work mortgages in
the securities they purchase in order to prevent people from going into
foreclosure as this is the central cause of the crisis
Republicans, typically, are against Government intervention
into the Financial Markets. They believe
the markets will regulate themselves, and that banks, just like anything else, should
be allowed to fail. Some Republicans in
congress favor a plan that, instead of purchasing CDO’s, lends Wall Street
banks money to remove some of the burden caused by mortgage backed securities.
Caught in the middle of all this are the two Presidential
candidates, Senators Barack Obama and John McCain. Both candidates are trying to juggle their
knowledge that the government has to do something to stop this crisis, with
their knowledge that the average American is against the bailing out Wall
Street. John McCain has the unique task
of calling for the kind of regulation needed to prevent problems like this from
happening again, despite the fact that he’s fought against this kind of regulation
in the past.
When the final details of this proposal are finally agreed
(or not agreed) to, we’ll take a look at how everything we talked about above
gets worked out… stay tuned!
