The problem at the heart of the demand from the financial sector for a bailout of Fannie Mae, Freddie Mac, and other failing financial businesses comes down to one very simple thing, the practice of many modern businesses of relying on the availability of large amounts of easy credit for their day to day operations.
Fannie Mae, Freddie Mac, and banks and other institutions dealing in mortgages essentially sucked up all the credit. As real estate prices went down, the assets supporting their over-leveraged loans went down in value and all of a sudden the credit they were using exceeded the credit which should have naturally been available in the marketplace and as a result credit for everyone else started to disappear.
For Mr. Joe Citizen this means it's currently quite hard to get a loan from certain sources, though you might be surprised to find that your local credit union or small bank which has always lived within its means has no real problem giving a credit-worthy customer a loan at a very low rate. For Mr. Fred Corporate Fat Cat it means that all the short-term credit tricks he used to pull to meet payrolls while lining his pocket and expanding his operation all at the same time are no longer available. All of a sudden he finds he has to use his actual revenues to pay his bills, including payments on past loans.
So while Mr. Joe Citizen just decides he doesn't need a cash-out refinance to convert the outhouse to a sauna, Mr. Fred Fat Cat goes a little crazy and runs screaming to the government for some sort of assistance because he's forgotten how to run a business that operated on a simple cash profit basis.
But wait. Might a lot of this just be irrational panic?
Seventy percent of the businesses in the US are small businesses which do operate on a standard cash profit model. They make stuff or buy stuff and then sell it at a markup and use the profits to cover expenses and make or buy more stuff, and so on. They don't actually need extensive credit beyond maybe the mortgage on their property. The same is true of many quite large corporations who operate on a simple business model despite their size. So in fact the panicked companies are quite small in number and although they may be quite large in size and financial footprint, they still make up only a small fraction of the total economy.
Article comments
— go to most recent comments1 - Arch Conservative
Well it is an election year so it's not that surpsising that we're seeing such gross distortions and exagerations of a subject that most Americans know affects them but do not actually understand the finer points of.
2 - wildnfree
Dave,
I haven't been here in a while. I spent part of this afternoon carrying a sign protesting this latest bailout as well as annoying my entire email list by sending them the contact information for our local representatives. Not once outside of the internet, a couple of Fox interviews of a certain former presidential candidate and a Senator or 2 with the cojones to disagree with this in person, has anyone even mentioned the alternatives you speak of.
This is more about increasing power through fear than actually helping our financial situation.
Wildnfree
3 - Ruvy
Well, Dave, you finally finished your own bailout article. You must feel relieved. Bailed out, perhaps?
Your ideas may make sense, but I do not see an intelligent solution being adopted by a Congress scared for its seats. I foresee only panic.
And you know what panics result in, right?
4 - pleasexcusetheinterruption
Great article. Appreciate the time and effort that went into this.
5 - Silas Kain
Here, here, Dave! I say Congress should proceed with extreme caution. A rush to bail-out is not the answer.
6 - Lee Richards
The fact that such revolutionary legislation is being rushed through is strong evidence that members of congress in both parties care more about getting the crisis off the front page until after the election than they do about the future of the people and country they supposedly serve.
7 - Cindy D
In Achmed the Dead Terrorists words, "If this s paradise, I've been screwed."
8 - David Moran
It seems to me the problem is the size of these companies. They are deemed too big to be allowed to fail. Given that's the case shouldn't there be limits on how large these financial institutions can grow. And aren't the current mergers and bargain basement takeovers only going to exacerbate this problem.
9 - jamminsue
Dave:
1. Capital has been vacuumed permanently for military outlay, the financial world is not alone in this problem. I find it interesting that the amount needed for this infusion is about equal to what has been vacuumed for Iraq.
2. Covering over-valued securities is terrible, but at least we have a chance at some return.
3. Not everyone that needs loan money is lazy or a "fat cat." I work for a construction company. Three of the six jobs we are working on were being financed by a local bank that failed, so are having to wait at least 60 days beyond the usual 45 for payment for services. We are not irresponsible, that is the way construction is done. The projects are viable, the owners are responsible, and as far as I know the bank was a prudent lender.
4. Greed is something that must be controlled; it is an inherently human characteristic that will not "take care of itself." It must be controlled with laws and public censure which is a fact of life. Those that cry for deregulation are probably the greedy ones, complaining they didn’t get their share of the booty. As you say Gingrich is a proponent of deregulation, my case is made. Greed made SOX necessary. Ask anyone who is an ex-Enron employee and the public accounting industry as a whole.
Hard as the idea is to take, these are the lessons we should take from history and understand some controls are necessary if we are to proceed responsibly.
The ancient adage “Absolute Power Corrupts Absolutely” is quite appropriate in this case.
10 - Rufus Brown
Sure, bail out all the rich whiteys who commit white collar crimes. Meanwhile, a poor nigga can't get bailed out of jail because his family ain't getting no help.
The American system is racist, corrupt, and evil.
11 - Dave Nalle
1. Capital has been vacuumed permanently for military outlay, the financial world is not alone in this problem. I find it interesting that the amount needed for this infusion is about equal to what has been vacuumed for Iraq.
Which is entirely coincidental. There's certainly no causal relationship between the two. But if you think there is, please explain how spending on the war can cause excessive lending to unqualified borrowers. I'm interested to hear it.
Just a hint. Spending on the war does not, in fact, go out of the economy. It goes to pay salaries of US soldiers, US contractors and for weapons and equipment manufactured in the US. So while it goes out of the government coffers, much of it stays in the US economy.
2. Covering over-valued securities is terrible, but at least we have a chance at some return.
Says the man sitting at the bottom of the outhouse waiting for the sun to shine through the hole in the door.
3. Not everyone that needs loan money is lazy or a "fat cat."
Where did you get the idea I was using 'fat cat' in a negative way. I was just differentiating between those who need loans to buy houses and those who need loans to do business.
I work for a construction company. Three of the six jobs we are working on were being financed by a local bank that failed, so are having to wait at least 60 days beyond the usual 45 for payment for services. We are not irresponsible, that is the way construction is done. The projects are viable, the owners are responsible, and as far as I know the bank was a prudent lender.
Construction is one of the industries which relies a great deal on interim loans, so it's going to be particularly vulnerable when there is a tightening of the credit market, not just at your level, but all the way up the industry. But the fact is that new home starts are up nationwide, so there's no evidence that the credit crunch is having a significant negative impact.
4. Greed is something that must be controlled; it is an inherently human characteristic that will not "take care of itself."
Theoretically the greed of each individual or group can be set against that of others so that no one gains too much of an upper hand. That, of course, requires some sort of relatively level playing field.
It must be controlled with laws and public censure which is a fact of life. Those that cry for deregulation are probably the greedy ones, complaining they didn't get their share of the booty.
I don't see it this way at all. Those that cry for deregulation are likely those who want to see the economy grow without arbitrary restrictions, to the benefit of everyone.
As you say Gingrich is a proponent of deregulation, my case is made.
Why? Outside of his political work he's a novelist. How does deregulation benefit him personally?
Greed made SOX necessary. Ask anyone who is an ex-Enron employee and the public accounting industry as a whole.
It made regulation necessary - but it always had been. There's a different between reasonable regulation which takes the form of oversight and guidance and intrusive regulation which attempts to run business based on arbitrary creiteria determined by bureaucrats.
Dave
12 - Silas Kain
Well, my friends, if you've any shadow of doubt about this bail out plan, I urge you to call your local Congressional office first thing in the morning. I am calling my Rep and I'm shouting, "JUST SAY NO!" (sorry, Nancy, drugs lately are the only thing that get me through this mess.)
And I would like to point out that there is no provision for home owners who are making mortgage payments on undervalued property. There's a small portfolio of mortgages belonging to home owners in the $250K - $600K range who will ultimately lose in this bail out. For the fat cats who overspent on their homes I have no sympathy. The problem is that the forgotten little people will lose their homes. And the fat cats who have a little nest egg left will scoop up all these properties at fire sales nation wide. So, once again, the rich get richer and the poor get intercourse.
13 - jamminsue
Dave, I have maxed my "fun time" this week, I work full time (about 50 hors per week) and am going to college full time, so will work on digging up the stats on manufacturing, etc. later this week.
Sorry.
14 - Les Slater
“Just a hint. Spending on the war does not, in fact, go out of the economy. It goes to pay salaries of US soldiers, US contractors and for weapons and equipment manufactured in the US. So while it goes out of the government coffers, much of it stays in the US economy.”
Just a hint of how little Dave knows about economic fundamentals.
A first order approximation reveals that the military expenditures produce absolutely no value. The soldiers get paid but do not contribute any product or service that is consumable by those producing the food he eats, the house his family lives in, etc. This is also true of the material and ‘services’ provided by the military contractors. They are used to destroy. Again, all the wages, etc. of their employees are used to buy products for their survival and comfort which are made by workers and farmers producing real value.
A sector of economic activity is devoted to going down the drain which would otherwise go to consumption of other productive sectors.
It is nothing but a drain on the economy.
15 - Dave Nalle
So once again Les demonstrates that he clearly does not understand even the most basic elements of economics.
Your description of soldiers as a 'drain on the economy' is no different from the description of ANY government employee. And unlike other government employees they DO produce revenue for the economy beyond their sustenance because they consume a large amount of very expensive hardware and munitions, the consumption of which feeds a variety of industries.
Admittedly, it's all tax money. But better that money should go back into our economy than otherwise.
If we were not at war, what would be done with that money that would benefit our economy more than war spending?
I suspect that as a marxist Les forgot that consumption is an essential part of any economy.
None of this is a justification for the war, but to say that war spending is basically just throwing money away is totally untrue.
Dave
16 - Les Slater
Dave,
“Your description of soldiers as a 'drain on the economy' is no different from the description of ANY government employee.”
I would certainly agree here, at least in most cases. But do you deny that most of the government bureaucracy is a ‘drain on the economy’?
“And unlike other government employees they DO produce revenue for the economy beyond their sustenance because they consume a large amount of very expensive hardware and munitions, the consumption of which feeds a variety of industries.”
Yes, and to the extent the ‘products’ go up in smoke, do not provide any commodity or service to the real economy. And to the extent that labor, material and capital are expended in other industries, to provide to military industries, those are also wasted.
“Admittedly, it's all tax money. But better that money should go back into our economy than otherwise.”
More importantly than the fact that it’s ‘tax’ money is that it is ‘money’. Your, ‘…they DO produce revenue…’ leads to some enlightenment here. What is money that does not have the commensurate commodity and useful services to back it? It’s called inflated money.
“If we were not at war, what would be done with that money that would benefit our economy more than war spending?”
Produce products that are necessary for the survival and comfort of the population.
“I suspect that as a marxist Les forgot that consumption is an essential part of any economy.”
Read my preceding sentence, ‘Produce products that are necessary…”. Do you suggest that I recommend that these products just be admired for their intrinsic value, the labor that went into them? No, it is obvious that they are to be CONSUMED!!!
Les
17 - Joanne Huspek
Good article. What it doesn't address (and no one else seems to be doing it either) is the fact that many businesses don't misuse credit. I can vouch for my own. Many people weren't financially irresponsible and took out loans they could afford. I guess we suffer for the misguided actions of others.
As for the military being a drain on the economy, I am an ex-Army brat, and I can tell you that local economies LOVE it when bases pump up their numbers in anticipation of deployment. More people = more money flowing for stores and services. Dependents = more school aid. Perhaps some look at it like government "waste" or economic "bail out" but to me it looks like an economic shot in the arm. We're going to always need a military, right?
18 - Les Slater
Joanne,
“I am an ex-Army brat, and I can tell you that local economies LOVE it when bases pump up their numbers in anticipation of deployment.”
Any enterprise in a community affects the economy of that community. The difference is that most enterprises actually build products or provide services. The military sucks up services from the community. The funds to do so come from the tax base or borrowing from China.
The military produces nothing economically of value that can be consumed by the population.
Les
19 - Joanne Huspek
That's true, Les. But what's the alternative? Dismantle it all and sing Kumbaya?
20 - Clavos
The military produces nothing economically of value that can be consumed by the population.
No part of the government does.
21 - Jordan Richardson
That's true, Les. But what's the alternative? Dismantle it all and sing Kumbaya?
Try it. You might like it. At the very least, stop spending so much damn money on it.
22 - Les Slater
Joanne,
“That's true, Les. But what's the alternative? Dismantle it all and sing Kumbaya?”
U.S. foreign policy is carried out in the interests of a small minority of the population, namely the super rich that not only own the two major parties but the vast majority of information dissemination and opinion making.
It is not in our interest to have this military. It is not our military. It does the bidding of our enemy. As things get worse and worse it will be used against us.
Les
23 - Dave Nalle
See, this is why there's no point arguing a point like this with Les. He doesn't understand that in a capitalist system the interests of the rich are ultimately inseparable from the interests of the population as a whole.
Plus, at the end of the day Les will end up classifying any of us who earn over the median income as either members of the wealthy elite or their bourgeois lackeys and insist that we have our assets taken away and our income 'equalized'.
He also seems not to understand the idea that the US has always had a consumption-driven economy and that super-consumers like the military are just as valuable in their way as producers of actual goods.
Dave
24 - handyguy
Although we've all been using the shorthand term 'bailout' for the [just rejected!] Paulson plan, I think it's a misnomer.
Dave implies that relatively few companies were affected, and he's still fixated on Fannie and Freddie, which the government is already running.
But Wall Street as it was a year ago has ceased to exist. There are no large investment banks left. Bear Stearns, Lehman Brothers, Merrill Lynch, all gone or sold to other companies. Goldman Sachs and Morgan Stanley are restructuring themselves as 'bank holding companies,' meaning no longer investment banks.
Paulson would not be bailing out companies. He would be allowing the credit markets to return to normal. Some of the individual companies could still fail and may well do so.
The reason the Dow just dropped over 750 points is that many working in the credit markets, and many watching them closely, know how dangerous the situation is, and how fast and wide the contagion could spread.
This is by no means about a few big foolish companies. It's about a culture of debt, from individuals running up their credit cards, to governments running up deficits, to companies investing huge sums of borrowed money.
Even the surviving big banks like Citigroup are still trying to come to grips with bad mortgage securities they own, though they just absorbed Wachovia.
Some folks on both left and right are allowing their knee-jerk ideological reflexes to prevent them from seeing the situation as it is -- opposing the Paulson plan in populist, nay-saying, know-nothing terms.
As I've said before, read Steve Pearlstein of the Washington Post, or find his recent interviews on Hardball and This Week with George Stephanopoulos. He is remarkably convincing on the point that not passing this plan is a near-guarantee of imminent disaster.
25 - Dave Nalle
I have to agree with your second to last paragraph, Handy. Most of the reaction to the plan is irrational and makes no sense at all. I don't believe that my article falls into that category.
I'm all for a plan. I'm just not convinced that the plan we were offered originally or the minor variations of it being discussed or the variant of it being voted on today are necessarily the answer or the best answer to the credit problem.
They may be answers, but they are answers which are just as driven by hysteria as those who are demanding 'no bailout'. What I want to see, as I hope this article made clear, is some reasoned consideration of sensible alternatives and not just a rush to throw money at the problem because it seems easy and obvious.
Dave