The bailout: we’re not bailing Wall Street, but the Main Street

September 29, 2008

It’s been a while since my last post. I’m going through some changes in life. I’ll be leaving my current job in two weeks and starting a new one with a new role.

I’m excited as well as scared. Changes can be good, but they also can be bad. Things are stable for me now. I have a good job, make good money and a great work environment. But this is an opportunity that I would regret not taking. Regretting NOT doing something is worse than regretting doing something.

But I had to blog about this bailout.

The general public is against the bailout. “Why should we use our tax money to bail out those Wall Street executives?”

However, things are not as simple as they seem. First of all, this isn’t a bail out plan. It’s an Economic Stabilization Plan.

It’s so complicated, that I’ll simply quote John Mauldin instead of trying to explain it:

Why do we need this Stabilization Plan? Why can’t the regular capital markets handle it? The reason is that the problem is simply too big for the market to deal with. It requires massive amounts of patient, long-term money to solve the problem. And the only source for that would be the US government.

There is no reason for the taxpayer to lose money. Warren Buffett, Bill Gross of PIMCO, and my friend Andy Kessler have all said this could be done without the taxpayer losing money, and perhaps could even make a profit. As noted above, these bonds could be bought at market prices that would actually make a long-term buyer a profit. Put someone like Bill Gross in charge and let him make sure the taxpayers are buying value. This would re-liquefy the banks and help get their capital ratios back in line.

Why are banks not lending to each other? Because they don’t know what kind of assets are on each other’s books. There is simply no trust. The Fed has had to step in and loan out hundreds of billions of dollars in order to keep the financial markets from collapsing. If you allow the banks to sell their impaired assets at a market-clearing fair price (not at the original price), then once the landscape is cleared, banks will decide they can start trusting each other. The commercial paper market will come back. Credit spreads will come down. Banks will be able to stabilize their loan portfolios and start lending again.

Again, the US government is the only entity with enough size and patience to act. We do not have to bail out Wall Street. They will still take large losses on their securities, just not as large a loss as they are now facing in a credit market that is frozen. As noted above, there are many securities that are being marked down and sold far below a rational price.

If we act now, we will start to see securitization of mortgages, credit cards, auto loans, and business loans so that the economy can begin to function properly.

What happens if we walk away? Within a few weeks at most, financial markets will freeze even more. We will see electronic runs on major banks, and the FDIC will have more problems than you can possibly imagine. The TED spread and LIBOR will get much worse. Businesses which use the short-term commercial paper markets will start having problems rolling over their paper, forcing them to make difficult cuts in spending and employment. Larger businesses will find it more difficult to get loans and credit. That will have effects on down the economic food chain. Jim Cramer estimated today that without a plan of some type, we could see the Dow drop to 8300. That is as good a guess as any. It could be worse. Home valuations and sales will drop even further.

The average voter? They will see stock market investments off another 25% at the least. Home prices will go down even more. Consumer spending will drop. What should be a run-of-the-mill recession becomes a deep recession or soft depression. Yes, that may be worst-case scenario. But that is the risk I think we take with inaction.

A properly constructed Stabilization Plan hopefully avoids the worst-case scenario. It should ultimately not cost the taxpayer much, and maybe even return a profit. The AIG rescue that Paulson arranged is an example of how to do it right. My bet is that the taxpayer is going to make a real profit on this deal. We got 80% of AIG, with what is now a loan paying the taxpayer over 12%, plus almost $2 billion in upfront fees for doing the loan. That is not a bailout. That is a business deal that sounds like it was done by Mack the Knife.

This deal needs to be done by Monday. Every day we wait will see more and more money fly out the doors of the banks, putting the FDIC at ever greater risk. Panic will start to set in, moving to ever smaller banks. Frankly, we are at the point where we need to consider raising the FDIC limits for all deposits for a period of time, until the Stabilization Plan quells the panic.

I understand that this is a really, really bad idea according classical free-market economic theory. You know me; I am as free market as it comes. But I also know that without immediate action a lot of people are really going to be hurt. Unemployment is not a good thing. Losses on your home and investments hurt. It is all nice and well to talk about theories and contend the market should be allowed to sort itself out; and if we have a deep recession, then that is what is needed. But the risk we take is not a deep recession but a soft depression. The consequences of inaction are simply unthinkable.

Joe, I am telling you that the markets are screaming panic. Yes, Senator Richard Shelby has his 200 economists saying this is a bad deal. But they are ivory tower kibitzers who have never sat at a trading desk. They have never tried to put a loan deal together or had to worry about commercial paper markets collapsing. I am talking daily with the people on the desks who are seeing what is really happening. Shelby’s economists are armchair generals far from the front lines. I am talking to the foot soldiers who are on the front lines.

Every sign of potential disaster is there. You and the rest of the House have to act. It has to be bipartisan. This should not be about politics (even though Barney Frank keeps talking bipartisan and then taking partisan shots, but I guess he just can’t help himself). It should be about doing the right thing for our country and the world. I know it will not be fun coming back to the district. Talking about TED spreads and LIBOR will not do much to assuage voters who are angry. But it is the right thing to do. And I will be glad to come to the town hall meeting with you and help if you like.

With your help, we will get through this. In a few years, things will be back to normal and we can all have stories to tell to our grandkids about how we lived through interesting times. But right now we have to act.