Wednesday, October 1, 2008

Why We Need the Bailout

The past month has been dramatic, and certainly the past few days are no exception. With a whirlwind of controversy over the failed bailout plan, there seems to me to be some misplaced rage. Thomas Friedman's Op-Ed, Rescue the Rescue, hits the nail on the head.

Count me in to tar and feather the brokers, who James Cramer lays blame to in a recent New York Magazine article:

The unraveling started with brokers searching for new income streams after the post-dot-com collapse of equities. With the Federal Reserve taking interest rates down to 1 percent to jump-start the economy after 9/11, these firms’ clients were desperate for bonds that could give them a higher return than risk-free Treasury bonds. With low short-term rates available to tease borrowers, as well as what seemed to be endless home-price appreciation and a glut of global cash seeking a home, the brokers decided to package all sorts of arcane mortgages into bonds and sell them to institutions and hedge funds around the world. The whole scheme rested on the underlying value of those homes, which would never decline again—right?

Count me also as first in line to spit on the shiny shoes of every top one percenter tax bracketeer whose greed got us in this mess to begin with, and surely aren't worried about how they're going to pay for their Metrocard this month--bailout or no bailout.

And yes, as I've railed about before, it's we the little people who got snookered and we the little people who are now footing the bill. So the rage is real, but to be against the bailout is directing the anger to a place more akin to shooting yourself in the foot, when you were aiming for Richard Fuld.

Look, when people are talking about a credit freeze that involves a $700 billion bailout, rest assured they're not talking about someone taking away one of your credit cards. While that is a real trickle down outcome of this mess, nobody is trying to spend $700 billion to help out your sorry ass. No, this is a business credit freeze. And while many people are like I give a flying duck, the fact of the matter is you should. Because our economy runs on credit- it literally fuels the engine that we all benefit from.

For example, a few friends of mine are designers. As small business owners, they do things like make clothes from scratch and other things beyond my meager talents. So they design something and send it off to a factory, the factory bills them (ie credit) and they have X amount of days to pay. Then they sell their clothes to stores, and in turn bill the stores who have X amount of days to pay (ie credit). If somewhere along the line someone can no longer afford to extend X amount of days to pay, it is a chain reaction, and as we all know, you can't pay unless you got paid. It would simply not be possible to be a fashion designer, small potatoes or big kahuna, and pay everything up front.

Another example-- take restaurants, a dime a dozen in NYC and our motherlode of small businesses. When a restaurant or bar buys liquor from a distributer they have an approved credit line. Liquor is expensive, especially in large volumes, so they get, say, 30 days to make money off it and then they're able to pay their bill. For a restaurant to pay up front for liquor, for restaurant supplies, for all food deliveries, etc., it would cripple the business and they would go under. Not because they were poorly run, necessarily, but because you need credit to take risk, to make a profit, to get paid. If the liquor distributer suddenly loses its own ability to buy on credit, whether because credit is frozen or the interest rates are raised too high, the subsequent effect on restaurants in the city would be none too pretty.

And on a larger scale- you think H&M or Old Navy pay everything up front before they've had somewhat of a chance to sell to us, make a little money and pay back what they've borrowed? You think Sony delivers a flat screen TV to Best Buy already having paid in full what it cost to make and ship those thousands of flat screens? Obviously not, and now we get into commercial paper. Commercial paper is basically a money market security issued by the big boys to cover short term debt, such as inventory. It's only really available to highly rated businesses, and presumably safe so the yield is low for people who buy it. You have to buy a lot of it to be able to buy it, so usually money market funds buy it, not people like you and me. With a low interest rate, it allows big business to do what it does on a daily basis, just like a factory billing my friends for their order on 100 dresses allows them to do what they do.

And that's why we need the bailout. Because some very bad decisions by some very wealthy people are clogging the entire capitalist system, of which we're all a part of no matter how left you lean. Unless you lean so left you're Thoreau, and you paid for your pond in full, in which case you're good to go. For the rest of us, we can only hope for a plan that addresses the needs of taxpayers with transparency, accountability, and the ability to recoup the loan. Perhaps most importantly, the bailout is only the first step in repairing what broke in the first place (and yes, that's a loooong list). Because prevention is a whole other issue, and if there is any kind of silver lining it's that our government just might have the motivation now to finally hold Wall Street accountable with honest regulation.


Andrew Stevens said...

Thank you for this. I've been trying to patiently explain to my friends on the left that this bill is not just about giving money to failed Wall Street fat cats and patiently explaining to my friends on the right that this bill is not just about socialism and socializing losses that should be absorbed by the people who took the risks. The bill fundamentally is about avoiding a liquidity trap and injecting capital into the system when monetary policy is inadequate to do the job (so-called "helicopter money"). From 2001-2007, we have had the greatest global economic boom in history. In order to avoid following up with the greatest global economic bust in history, the system needs more capital. And the only entity on the face of the planet with the credit to inject that capital is the United States federal government.

Whether you're for FDR style regulation or Reagan-Clinton style deregulation isn't the point right now. We can debate at a later date whether Bush's re-regulation with Sarbanes-Oxley was a good idea, whether Clinton should have repealed Glass-Steagall, whether Bush's SEC should have enforced rules on naked short selling or not done away with the uptick rule, whether Paulson should have rescued Lehman Brothers or continued to pay dividends on Fannie and Freddie's preferred stock, whether rating agencies were corrupt, how much leverage a company should be allowed to have, whether the accounting scandals at Fannie and Freddie should have been "solved" by their promising to put more money into affordable housing, whether we need more regulation on off-balance sheet vehicles, mark-to-market pricing and all of that. (Whether you're for more regulation or less regulation, we can all probably agree that we've got the wrong regulations right now.) But right now we need to do whatever we can to mitigate the damage and that means unfreezing credit markets.

PiggyBankBlues said...

thanks, andrew- my sentiments exactly!

it's funny, b/c i have been trying to do the same explaining to my friends, and last sunday i tagged along with 2 generous friends to bill clinton's talk at the 92nd st. Y, and he talked about it in a way that my friends were like, oh my god, i get it for the first time. we need this bill.

anyways, you obviously know econ much better than i (the layman), so i appreciate your comments.

Andrew Stevens said...

Thank goodness for Bill Clinton, at least. I confess I listen to him every chance I can get, as well. The man is a genius at explaining complicated subjects in simple language. In fact, it was Bill Clinton who convinced me to support the Iraq War. (He was wrong about the WMDs, of course, but it was a perfectly understandable error given that Hussein was doing everything in his power to convince Kuwait, Iran, and his own people that he had them while simultaneously trying to convince us that he didn't.)

By the way, the crucial mistake Paulson made was in allowing Lehman Brothers to fail. We can certainly debate at a later time whether "too big to fail" also means "too big to exist." (I'm inclined to agree with the sentiment.) But given that we have these highly interconnected behemoths, it turns out that it behooved us to rescue all of them, not for their sakes (the executives of all the rescued firms so far have been kicked to the curb, the people who made the mistakes have all been fired, and the shareholders' stock is now essentially worth zero), but so it didn't start a cascade effect which took down perfectly good businesses and the economy in the process. This cascade effect began to occur when Lehman Brothers failed. That triggered the Reserve fund "breaking the buck," which triggered a flight from money market funds and even banks. (I was puzzled at first as to why Obama and McCain were talking up raising limits on FDIC insurance to $250,000 temporarily. Almost anyone who has more than $100,000 sitting in a bank splits it among multiple institutions already. Then it occurred to me that they probably chose to tackle that issue just to inform people about FDIC insurance, since many Americans had started taking their money out of the bank in fear for its safety, even though it's perfectly safe.)

I'm not in love with the bill before Congress. If we had time, we would certainly use it to craft a better bill, but there's a real danger the economy won't be there anymore by that time. As it is, I don't think it's a bad bill. It won't prevent a recession, but it might prevent a depression.

blixity said...

fantastic pbb! yes, agree there must be a bailout. also, (even as the markets are taking a pounding with apparent reluctance of congress to approve) i definitely appreciate that politicians are taking the time to debate this one. i look back to 9/11 and the climate of panic it created and the rush to attack, to hand over executive power without due diligence. FINALLY, some politicians seem to be learning from past mistakes. good decisions take time. we can't afford another box of bandaids.

Lacey said...

This was a great post! There is so much turbulence in the market today, and people need peace of mind more than ever. I wanted to offer your readers a link to another blogger who is doing great work. He writes about our 'childhood money messages' and how the best approach to stability in today's market is to resist letting these emotions control our buying/selling habits. It is really fascinating work, and something you should all check out. His name is Spencer Sherman, and you can view his blog at