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Ways of the World

Carol Stone, business economist & active Episcopalian, brings you "Ways of the World". Exploring business & consumers & stewardship, we'll discuss everyday issues: kids & finances, gas prices, & some larger issues: what if foreigners start dumping our debt? And so on. We can provide answers & seek out sources for others. We'll talk about current events & perhaps get different perspectives from what the media says. Write to Carol. Let her know what's important to you:

Monday, September 29, 2008

Q & A on the Mortgage Bailout

As you might well imagine we might have been doing today, we were well along with some commentary for you on the pending mortgage market bailout legislation. In fact, we were writing what was probably the second-to-last paragraph. Then the House of Representatives vote on the bill took place. And we watched CSpan in disbelief as the House defeated it, 205-228. Sigh.

We, like an overwhelming share of readers on an AOL news service poll this afternoon, believe "some kind of bailout will pass". Thus, we still present our views on this issue, pretty much as we were drafting them. The last paragraph is different than it would have been, though!

Who Gets "Bailed Out"? Aren't the taxpayers getting stung?
First, as someone commented at the church coffee hour yesterday, "Oh, 'they' will make lots of money and the rest of us will just be stuck for the cost". Well, I don't think anyone will make lots of money off this. I know people don't like this giant program. But it's not going to make anyone rich. The shareholders in all the affected companies are seeing those stocks become virtually worthless. The bailout bill contains stringent pay caps for the senior executives of any bank selling mortgages to the Treasury, and at this point those executives are just lucky to still have a job.

The taxpayers do shoulder some cost, but how much that ends up being is presently an open question. Obviously, there are the outlays to buy the mortgage securities. But right away, there will be monthly cash inflows from any of the mortgages the borrowers are paying on. If, over time, some of the loans get rehabilitated, they can be sold back to the private sector and the Treasury may well make a profit on them. And if a foreclosure sale eventuates anyway, the Treasury will get some cash from that. Thus, while the outlays for the government's purchases may run to $700 billion, that should be a ceiling. The eventual cost should turn out substantially less.

So, it seems to us that if anyone is getting "bailed out", it's the homeowners. They've got a second chance here to fix up their loan record and get their financial lives straightened out. Some of this rehabilitation already goes on, sponsored by an alliance of lenders and counselors called Hope Now, and the proposed legislation would intensify these efforts.

What does the bailout do? Will it solve everything?
No, it is not a panacea. What the bailout can do is buy some badly needed time. As you can see from the rapid-fire sales and conversions of heretofore evidently fine financial institutions – Wachovia Bank, Merrill Lynch, others – this situation has moved remarkably quickly. No one has had time to regroup. So this plan will put some assets that are in the worst condition into the hands of the government, an entity that does have time to hold them until they can be "worked out" or disposed of in an orderly fashion. With these troubled assets off their books, the banks facing losses from them can proceed to stabilize and resume growth in lending.

Growth in bank credit is no small matter: it is already the case that total bank lending has been flat for the past six months, especially including consumer and business loans. It's really hard to have economic growth without credit growth, so getting that back on track is a genuine need that affects consumers, small business owners and corporate managers alike.

A specific concern well beyond this legislative plan is the hit to the economy already delivered by high energy costs; these have let up recently, of course, but the heating season will still squeeze consumer pocketbooks hard.

We did see one press statement that the bailout plan wouldn't even help house prices to stop falling. That doesn’t seem to follow, by our way of thinking. If we can stabilize the mortgage markets and slow or stop distress sales, that ought to provide some direct support to home prices.

How Much Is $700,000,000,000?
The value of the mortgage security purchases authorized for the program would be $700 billion. A friend wants to know how much that is in real money? We're not sure exactly how Treasury Secretary Paulson derived this figure, but here are some comparisons we can offer.

The Government's fiscal year 2008 ends tomorrow, September 30. It will have spent just under $3 trillion, so the mortgage program amounts to just under 25% of the current magnitude of the Federal Budget.

On June 30 all home mortgages that were outstanding came to $11.254 trillion. The program size is thus 6.2% of the total home mortgage market.

6.2% is roughly the current fraction of these mortgages that are "seriously delinquent" (60 days or more late in their payments) or in the foreclosure process.

In a completely different context, 1 billion seconds = 31.7 years (60x60x24x365.25). So 700 billion seconds make 22,182 years.

I'd rather think about it from Everett Dirksen's perspective (you do remember that other Senator from Illinois, Everett Dirksen, don't you?): "A billion here and a billion there, and pretty soon you're talking about real money."

Where Do We Go from Here?
This is the new last paragraph after the House defeat of the plan. The next few days look pretty murky at the moment. Major stock indexes fell by 7% to 9% on the day, equal to 777 points on the Dow Jones Industrial Average. At least two major banking merger transactions in the last few days, the takeover of Washington Mutual by JPMorgan Chase and the hasty sale of Wachovia Bank's assets to Citigroup, had valuations that envisioned the plan's passage. Other sizable capital investment transactions were also predicated on the relief the program would bring. As we noted at the outset here, we believe "something will happen" during this week before Congress adjourns to go home and face the people.

These events emphasize two concepts we now intend to devote more space to: the mortgage loan rehabilitation efforts, which are far more developed than we'd understood before. If a loan goes into foreclosure, that marks defeat for the homeowner and for the lender. We'll talk in some detail about what they do to try to prevent that.

Second, we want to talk about "capital" and "liquidity". Both of these crucial supports to business activity have played enormous rolls in the rapid developments among the world's major financial institutions. What are they, and why does Main Street care about Wall Street's capital? We hope we can provide at least some better feeling about that.


Anonymous Anonymous said...

Many Americans here is Florence -- many of whom are pensioners whose plans survive on the strength of the dollar (so they've already seen their resources halved!) and the market are shocked and angered by the simplistic "us versus them" defeat of the bailout. Even I understand that Main Street vs Wall Street is a false choice, and I don't understand much.

9/30/2008 2:25 AM  
Blogger Crossfire said...

Delighted to read your excellent comments. To date, most sources of information on this topic have left me with too many new unanswered questions. I approach this whole new complex problem using my tried and true instructions for eating an elephant which is "one small spoonful at a time".

10/03/2008 2:37 PM  

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