A synopsis of the "bailout"

This was written by my brother, Juan. I've edited a little to clean some stuff up but I have not changed any of his points. Bascially just spelling and grammer, but only where I thouhgt I must.

Take a look and tell me what you think.

The History

People have to start by looking at the root causes. In the late 90s, Alan Greenspan went crazy trying to "eliminate inflation" and cut rates to the bone, to get more money out to the country. We created wealth, and encouraged investment, which worked and spawned a technology boom and we saw big expansion in America. Things were by all accounts good - too good. It was a boom, rather than steady growth. But it is starting to seem like he went a little too far. Imagine blowing a bubblegum bubble - if you blow on it slowly, it grows. If you blow too much too fast, it pops. This had the unintended consequence of removing a good portion of the leverage the Fed has on the economy. (Generally, the Fed controls the money supply and interest rates. Lower rates encourage investment, and higher rates generally encourage savings). Well once you cut rates to the bone, you have no new incentives to make people spend, or stimulate investment.

Then we had George Bush's Admin in power. They got into office as the bubble burst. Now this is not to say that the bubble popping was Clinton's fault, or even Bush's. It was unsustainable growth. Then as the air went out of the market (NASDAQ, the technology company index, went from 5200 to 1500. - that is a whoopin' in anyone’s book) we had the second shoe dropping - the terrorist attacks. Again, not a fault of any administration. It’s not like GW and his policies were the reason for this, as the terrorists started planning under a more internationally popular administration. This essentially can be blamed on every admin definitely to Truman, and possibly all the way back to a time when the US was buidling ships to take on the Barbary pirates (thats the "shores of Triploi" reference in the Marine Corps hynm). Anyway, as the economy takes a beating on both fronts, the one area that props up the economic indicators is the housing market.

Now you have the change in the government. Up until the attacks, we figured we were all safe. I did. The attacks showed us how we were vulnerable. And then we created the "Homeland security dept.", and tried to revamp the immigration dept., and did all of these things that increased the size of government, not by choice, but as many saw as necessity. Unfortunately, there were no spending cuts to make up the added amount. Now we add in the war. Everyone was all gung ho about going in and blowing up bad guys. However, I doubt many were prepared for war like we are experiencing. Or the duration, or the cost. I believe the government was, but the American people turned when we didn't win and leave in 100 hours so to speak. And of course, there were things that were mishandled, and plans went drastically awry. But generally, it is another cost that derives no growth in the economy.

Congress now decides that the American dream is for everyone to have a home, in this great social Democrat dream of universal prosperity, and for more people to get credit. The administration looks and says hey, we are going out there and helping people own homes, so this MUST be good. Everyone of every party is in agreement so they go about helping boost homeownership. The congress voted for against a bill which would have limited the portfolio size of the Fannie Mae. I guess this was voted against on a party basis by the Deems. So Fannie gets bigger, and makes the future problem potentially larger. And like many people who don't understand what the real world is like, the people who agreed to all of this loosened policy all assumed wrongly that people who got credit and bought these houses outside of their means would live up to their responsibilities. Guess what happened? People around here who lost their jobs, and couldn't find work that could pay for their homes, or had to move to get work. I feel for those people... I really do. In those cases, foreclosures are not really due to bad decisions, and in many of those cases, I can see how it can happen to a lot of people. But that isn't the bulk of our foreclosures. Then there are the people who were given mortgages that were either too dumb to know that they couldn't afford them, had no intention of paying for them to begin with, or figured that they would get the benefits of great run ups in the market, and flip the house, or refinance it later when the value went up. Now, because there is a HUGE influx of buyers, housing prices start to rise and people take notice. Boomers buy real estate like crazy to prey on Gen X - like always. In 2006, almost 70% of the houses purchased were second houses, by boomers. People notice the money to be had, and decide to start to flip houses. It becomes so popular they make freaking TV shows out of it. A general rule of investing is that when everyone is in the market, it is time to get out. As loans went bad, banks and companies increased those lending standards again, and now you had far less money going into the housing market. Then you ran out of buyers, and these prices that were blown well in excess of fair value started to sink. Now suddenly, people who had bought were screwed, and rather than take the cash losses, they walk away.

Up to this time Fannie Mae is buying up all of these mortgages, and packaged them into collateralized mortgage backed securities which as essentially huge bonds based on mortgages. In a new shocking twist, I was told these things were rated AAA which is the highest credit rating you can get for a company, presumably because it was a quasi government agency. Well, the underlying value of these things collapses and Fannie's portfolio is devastated. So the government bails them out. However, a lot of banks had bought these types of investments, though not packaged by government, to park investments and monies. And the private ones fall apart too, and banks that used to have all of these assets start taking massive losses, and they collapse. Notice, the companies in the most trouble are investment banks, which packaged and held these assets, and banks that did a lot of mortgage work in California. Have you heard of PMI? Mortgage insurance? A lot of people who don't put down 20% have to pay insurance on their mortgages in case they fail. Well, the actuaries (the dudes that calculate the risks and the cost/benefit analysis to price insurance) gave them a potential risk. Not knowing just how bad these things could go, they underestimated, and the massive underwriters were now liable for up to 40 times their normal losses in the same circumstance. So now the insurance companies are screwed.

The Present

Foreclosures are ridiculously high, banks own properties that are worth significantly less than the loan that was defaulted on, and the broader economy is solid on a regional basis. This means that there are diversified areas of the country (Dallas and others) are doing well while places with a basis on manufacturing are in deep trouble - like here. And the government wants to bail out the companies that took the losses. The form of the bailout is in question. Some (Obama) call for reviewing each mortgage, and forcing the lenders to reduce the amount of the loan to an "affordable level" for the people. Some (more liberal jackasses) think we should add car debt and credit card debt into the package to give ordinary individuals a "break." Which is ludicrous. They also want to attach stipulations on any company that takes bailouts that will let the government decide who gets paid, and how much. While I see some of the bonus and pay craziness of some of the top execs, it goes against everything I believe in to allow the government to dictate what anyone should or shouldn't make. There doesn't seem to be a clear answer as to how the rest of the bailout is structured.

The Consequences

I will tell you, the other bailouts have good and drastically bad points to them. Fannie/Freddie and AIG are about the same - a boat load of cash is loaned to the company at a prohibitively high interest rate, plus a warrant for 80% of the value. If the warrant is not ever exercised - like pulling the trigger on the transaction, the government never gets that share and the shareholders get bailed out too. Now, considering that AIG is a large insurer, if they go under, the people who have non-mortgage policies, like life insurance, home-owners, you name it, get wiped out. So in some senses bailouts generally will protect those people who are completely innocent in all of this. And of course, on the other hand is the gross cost. If done as loans above the market rates, then the government earns on this deal, but it doesn't seem to be what they are talking about.

But as hard as I look, all I hear about is where we are in pushing the bill through, but no details. Sadly, the best details out there came from George W who said that government would buy up all the bad debt. When I hear that, I would imagine that means people who were in foreclosure would now owe the government, and the government would own the property. Sounds like a huge got auction and slumlord activity is on the horizon. Goodbye once nice neighborhoods.

However, if you tighten up the credit markets, and prevent people from gaining access to money, that is a bad thing, and could greatly hurt the broader economy. In some circumstances, I think it would be better for most people to have tightened credit, considering how poorly they did with more credit. In others, less credit than currently, means less money is spent, and the economy comes to a grinding halt.

Suffice it to say, that I don't like the direct bailout idea at all. The only people who should really be bailed out are people and companies that bought highly rated CMOs only to find out they were worthless - which is essentially a fraudulent sale. Essentially, bailing out the goofballs who didn't pay their bills angers me greatly - mainly because I was the sucker who did pay his bills, and went without because that was the responsible thing to do. And in truth, all a bailout really seems to do for most banks is keep them in business. It doesn't make housing prices go up. It doesn't protect people from assets declining in value. It doesn't really strengthen the market. It puts a band-aid on a sucking chest wound. But that is just one man's opinion.