I’ve said it time and again - I’m an economic idiot. But as far as I can tell, the government just took on a whole boatload of debt it can’t pay for, which means that the only way to compensate is to fire up the printing presses and make more money.
This, in turn, drives down the value of all the money in circulation. How much it drives it down is impossible to calculate, because the Fed no longer publishes these numbers, as of a few years ago. Suffice it to say that on top of the already devalued dollar (which is temporarily rallying, but analysts are warning that the gain is short-term) we will further diminish its worth, thereby debasing our wages and driving up the cost of goods and services.
For those of us living paycheck to paycheck, with no savings, investments, or even a 401K, this means that it becomes increasingly likely that we will have to struggle just to put food on the table even if our incomes and fixed costs (like rent) stay the same.
Meanwhile, the banks will have their most toxic liabilities wiped away by this government money-printing orgy, despite the fact that they basked in the profits brought in by the risky sub-prime market when the risking was good. Were they compelled to make bad loans by the government? Yes. Were they compelled to go hog wild and begin a systematic program of predatory lending and encourage people to buy homes with no money down who couldn’t afford them? No way.
In the interest of full disclosure - and to be fair in asking for accountability - I was one of those borrowers, and I lost my home in 2006 to foreclosure when the real estate bubble burst in Phoenix and I lost six figures’ worth of equity, one of the first dominoes to fall in the housing crisis. If I had known then what I know now, I would never have made the same decisions. I was inexperienced, stupid, and caught up in the hype. I made bad choices then, and I helped contribute to the problem through my own lack of prudence.
The banks that the government didn’t snatch up (Countrywide, Lehman Brothers, Wachovia) found buyers without a problem. If all banks couldn’t be so lucky, wasn’t it just because they owned worthless assets that the taxpayers are now overpaying for? If they had failed, how would our financial situation have been any worse than it is going to be because of the (pork-riddled) bailout? Hasn’t history proven that when our government tries to intervene to stop recession they only make things worse?
I know my questions are riddled with implications here but I’m still looking for answers. This doesn’t feel right. I can’t see how this is going to do anything but dig us a deeper hole. Until our economy switches from borrow and spend to save and produce, how can we find the bottom?
But as far as I can tell, the government just took on a whole boatload of debt it can’t pay for, which means that the only way to compensate is to fire up the printing presses and make more money.
This has nothing to do with printing money, but about market psychology, frozen credit markets and the threat of bank runs. And the $700 billion figure is not a “cost” figure but an “authorization to buy something you can later sell” figure.
Not to say that it will work out, but the logic of the bailout is to get the economy past the current freeze in the credit markets, which ultimately threatens all. (You cannot run a modern economy without credit; even the simplest of non-cash transactions like a widget company meeting its payroll requires somebody’s credit at some point in the process.)
The current credit freeze is the result of all these mortgages and mortgage-backed securities now sitting on banks’ books, which were purchased at prices that they cannot now fetch, meaning that banks are staring at insolvency and fears of bank runs are rife (no bank can survive a depositors run … indeed, the very logic of a bank is to lend more than you hold in cash at any one point). The lack of certainty and confidence makes it irrational for banks to loan money even to one another (this is how the widget company makes its payroll), which feeds the self-fulfilling-prophecy cycle of credit crunch and bank jitters.
Buying the assets needn’t involve printing money; the government can simply go into debt. The government differs from any private purchaser in that it can issue its own debt, cannot really and truly go kaput, and can absorb losses far greater than any private enterprise.
What the government is doing by buying these assets with debt is akin to assuming the debts, which is enough given that the logic is to put the government’s full faith and credit behind these assets and end their drag on confidence and willingness to lend on the assumption you will get it back. Unlike printing money though, the government will get real hard assets (the homes themselves) that it can sell at its relative leisure and thus give the markets time and the means to untangle how much all these assets are really worth, rather than have the market work under fear of imminent runs and overnight collapses. In the meantime, with these overvalued assets no longer on the books, banks can return confidently to the routine lending that is the grease of a modern economy. In the best of cases, the economy can correct relatively mildly and when times are better, the government can sell off these assets (and the company shares) at something closer to current value.
Or to put it another way, the government-does-nothing-and-the-worst-happens scenario probably wasn’t the sort of frenzied money-printing and debased currency you suggest. More likely it would have involved a deflationary spiral (which isn’t necessarily the worst thing, as long as one HAS a job) from a paralyzed business climate (meaning however, that you likely would not). The latter is more or less what happened in the Depression; the former banana-republic scenario isn’t the US style.
Steve,
I’m calling it the “No Banker Left Behind” bill.
Back to asset buying and solvency … a friend here at work was trying to sell me on how the Gubmint had to do this, because banks now have all these mortgaged-based assets that they “can’t” sell, because nobody is sure of the value of these things.
I called B.S. For us homeowners, if we have an asset (a house) that we’re trying to sell, and it doesn’t move at the offered price, what does that mean? It means the market is telling you that you’ve priced your asset too high. How do you determine the market price of your asset? Lower your price until a willing buyer is found — at that point, you’ve discovered the market value of your asset.
Simple, no?
But Victor’s hit it on the head — if VLFI’s (Very Large Financial Institiutions) had to actually “mark to market” their assets, they would be broke — meaning, bank failures.
And since they’re “too big to fail” - Wall Street has an economic gun to the temple of Main Street … a new plan has arisen.
Since VLFI’s can’t find willing private buyers for these junk assets at a price that will allow them to survive, Uncle Sugar will buy them at a price above the actual market value.
In other words, think of the Gubmint offering to take that Phoenix house off your hands for the amount owed, not the market value. Oops, folks like you and me aren’t “too big to fail.”
That’s my understanding of it.
peace,
It is absolutely terrible that the economy is built entirely on debt–but it is. I think the system needs to be reformed but I think the potential suffering that would be caused by letting credit freeze happen is too great. Reform must be slow and steady–first banks and borrowers need to be weened off of antisocial lending and borrowing.
Without the bailout there may very well have been a freeze in what is known as the commercial paper market (essentially a means of exchanging unsecured debt). This market is responsible for providing the funds necessary to facilitate the day to day operation of local governments and businesses (large and small) across the country. Companies have assets but often these assets are illiquid–debt is used to pay the bills in the short term.
Oh, and the hope is that Uncle Sugar can “flip” these assets and not lose our shirts — which only makes sense if you think the crash in housing prices is a short-term blip and that housing will start to appreciate significantly again in the next 3-4 years.
peace,
John,
Without the bailout there may very well have been a freeze in what is known as the commercial paper market (essentially a means of exchanging unsecured debt).
Help me out here. I understand that the commercial paper market is key here — but also, I thought that it was (a) already frozen, and (b) not showing any signs of thawing even with the passage of No Banker Left Behind.
peace,
Zach
What I’ve been hearing is that the freeze in the credit market is happening for a simple reason - the money is all gone. The entire economy has been built on bubbles for so long that we’re way, way outside our means, and 70% of the GDP is accounted for by consumption, which equates to the destruction of wealth, particularly considering the fact that we don’t produce goods here in the U.S. in anymore. We just keep shipping our money overseas, and now foreign countries own our debts too.
The assumption that the market will return to normal with a course correction (or tourniquet) seems predicated on the notion that we can continue to borrow and spend beyond our means, rather than begin saving and producing again.
And it’s getting harder and harder to find 2 economists who agree…
Steve,
Your analysis would be correct–if we had a hard currency (or even a somewhat firmer one). This crisis is exactly where the perverse elegance of our monetary system shines. In modern economics there is no such concept as “out of money.” Sure, I can be out of money, you can be out of money but the economy cannot be out of money–we can always make more! Inflation, you say? Who cares? The money is already worthless–there aren’t enough things, widgets, if you will, in existence to use up all the money that exists–but people value the green paper for its own sake! Just don’t let out too much money at one time and inflation will be low enough that people won’t even notice.
The entire system is built on confidence, a confidence scam you might say. The credit doesn’t exist because people and institutions aren’t willing to lend money; people to banks (a deposit) banks to businesses and so on. The bailout is simply to replace the imaginary liabilities with imaginary assets on the balance sheets of major lenders. people will deposit their money again and things will begin to go on as usual–then we can start reforming the system while the crisis is still on everyone’s mind.
If your theory of money were right wouldn’t credit markets overseas be just hunky-dory? After all, that’s where all that valuable money is going.
Simple. The need for liquidity.
Zach,
In order to “thaw” the credit market, the bailout bill has to be implemented, not just passed.
Further, It is not quite correct to say the MBS and CMBS securities are “junk” or “worthless.” It is more accurate to say that they are “worth less,” that is less then previously thought. There are still coupons coming in and money being generated. Most of the mortgages backing these securities are still active and paying. Admittedly, CMO’s are riskier but they too will probably be profitable in the end. I’d stay away from Interest Only SMBS secrutities but as I understand it they are a small proportion of the market anyway.
The problem with these securities is the difficulty in determining the precise percentage of bad mortgages in each of the bundles from which these securities are derived. Combine this with the fact that there is no standard valuation of these securities and that companies came to consider them highly liquid assets and you’ll see where the trouble is. Companies valued their own assets and the Lehman collapse forced an across-the-board revaluation at much lower values. Since these securities had been considered almost as good as cash that meant huge losses, overnight. There was no liquidity left and no prospective buyers willing to pay the original acquisition price.
These assets are really not that bad, even those derived from “subprime” mortgages are still largely decent investments–as a long term investment rather than a speculative investment meant to substitute for cash. I’d be thrilled if they were further sub-divided and sold to small investors, personally–though they would need further refinement as a commodity before I’d buy. By-and-large Americans pay their mortgages–I trust the majority of my countrymen enough to gamble that they’ll keep it up.
These assets are really not that bad,
Yes they are. If anyone actually believed the paper was worth 80% of the hold-to-maturity value, they would be willing to buy it at that price. And nobody,and I do mean nobody, is willing. Some of this stuff is worth 30cents on the dollar, some is actually worthless.
Given the collapse of housing prices (and commercial real estate, by the way), large areas of California, Florida, and Nevada, which had the largest part (by dollar value) of these mortgages, have seen house values drop by more than 50%, and they are still declining. Once you take out recovery costs, and the impact of foreclosures on house values, 30% is a realistic value for the securities. For the negative amortization loans, since they inflate the owed principal, you wind up with even less return than that, sometimes 20% or less.
So yes, they really are that bad. Some people will continue to pay $5,000 or $10,000 a month for 30 years when they can rent an equivalent house for $1500. Most won’t. Some, because of illness, divorce or layoff, will be unable to make the payments. Some will be able to force a writedown and renegotiate a better deal. Some will just abandon the mortgage and take the 5-year hit on their credit. They’ll be in a much better position to buy in a relatively short time, and in the meantime, they will be better able to save up some money, without the heartache and headache of coming up with the price of a good used car every month.
And house prices are staying down for a while. Before one can buy a new house, one must sell the old one. If you’re underwater on you loan by 50%, it’s really hard close out your old mortgage when the proceeds from the sale fall short of the mortgage principal by hundreds of thousands. And the people who walk away from their bad deals aren’t going to get a mortgage soon. Either way, there will be a serious crimp in demand.
Steve,
Really simple.
You, me, and everybody I know all work for rich people. If we don’t keep them solvent, then they won’t have the money to pay our salaries, and our kids will be hungry.
We need to bail them out for our good.
No, it isn’t fair. It is not fair at all.