FISCAL FALLOUT: Bailout Blunder

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!

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