Tuesday, September 23, 2008

About that bailout, er, those bailouts

I've been puzzling over why we're bailing out companies like Bear Stearns, Fannie Mae, AIG, and Freddie Mac, and why we're apparently going to be on the hook for $700 billion more. Here are a couple of articles about it from a decidedly non-interventionist point of view.

More or less, the argument is this; banks and investment firms are often highly leveraged--remember those "reserve ratios" you may have learned about in the history of the Depression? That's what we have here; borrowers with 5% equity in their homes and marginal income are bailing on their mortgages when they realize they owe more than the property is worth, and the payments are more than they can pay. Banks, in turn, find that they need to write off bad debts--and this means that deposits are imperiled.

But wait. We have FDIC, right? It's taken care of, right?

Nope. Remember that various companies, chief among them Fannie Mae and Freddie Mac, are in the business of buying those loans from banks, sometimes selling them to others. They're doing it on credit, too. Yes, we have people going into debt to buy debt--and then more of them going in debt to buy derivative investments on that debt. Evidently there are over $250 trillion worth of them.

So as this collapses, there are any number of institutions that will take it on the chin, ranging from your bank account, to your bank, to the big financial institutions on Wall Street. Stocks fall greatly, as do your mutual funds, and God help you if you need a new mortgage.

Sounds pretty bad, right? So here's the plan; the Treasury buys those bad debts and derivatives to take them off the books of banks and investment houses and make them solvent. A certain portion of those bad debts will be written off by the Treasury, and a certain amount will be recovered. The total cost might be far less than $700 billion if the economy recovers.

Now, the cost; we've taken up to $700 billion in money out of private hands, money that otherwise would have been available for private investment. The net result?

Stock markets decline, so do your mutual funds, credit will still be tight, and as an added bonus, the guys who caused the problem get off scot-free. What to do?

Remember that your bank can't sell a debt it doesn't own, and the investment firm can't make derivatives of assets that don't exist. Get yourself to Dave Ramsey's site and get started (if you haven't already) on his baby steps to financial freedom, and encourage your friends to do the same. The payoff is huge--eliminating debt is like getting a 10% to 40% raise in income for most people.

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