General Question

c3p0's avatar

700 billion bail out?

Asked by c3p0 (5points) October 3rd, 2008

We were chatting yesterday, and someone asked me why can’t the big banks just write off the “toxic” debt, why do they need to be bailed out.. can’t they afford to write it off rather than going bust? maybe an obvious answer but would be good to hear!

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10 Answers

Allie's avatar

We’d be bailing out the people and companies who had so much money invested and then lost everything. And it’s not like we’re just giving them money. We get ownership of parts of their companies and hold it until it’s worth something, then sell it back. Or at least that’s how I understand it. I could be mistaken..

And I think (I could be totally wrong here, correct me if I am) that they need to be bailed out because, well, they need the money. Banks don’t make the money themselves. It comes from the Federal government and is printed at the BEP. Banks are companies too and they can’t just say “Oh, let’s just forget about this $X billions of dollars.”

FiRE_MaN's avatar

people were buying houses they couldnt afford and since a lot of people were doing this the falue of houses was going down. then when the banks went to forclose on a house they would get it back but had to sell it for less then they paid for it originally so they were losing money and evenutally just went bankrupt.. correct me if im wrong haha because that is my understanding of the story.

googlybear's avatar

A lot of problems also arose with the mark to market accounting method also required institutions which held these mortgages to use the current fair market value of these assets even if they plan on keeping them for years and have no interest in disposing of them immediately.

cwilbur's avatar

The problem is that lending institutions wrote mortgages that were bad risks, usually based on bad information, and then sold them as investments. This is not such a bad idea in theory: if you have a $100K mortgage from someone with good credit, it’s going to be worth a good chunk of money over the long run, and if you’re a bank, you might be happy trading it to someone for stocks or gold certificates. But if that $100K mortgage is from someone who’s going to default on it, it’s not worth any money at all.

Now, the reason this is a problem is because banks depend on liquidity—the ability to move money around—as much as they depend on assets—the things they own. The way they generally handle this is by making short-term loans to other banks. See, if I’m a bank that has $50 million in assets and $1 million in cash, I can ask another bank, who might have $500 million in assets and $10 million in cash, to lend me $5 million for a couple days so that I can settle some accounts.

But now, if a large percentage of that $50 million in assets is mortgage-backed securities, no bank will lend me money because that $50 million on paper might really be worth as little as $2 or $3 million. It might be worth $50 million, or $80 million, once all the dust settles—but there’s no way to know that yet. And so the other banks won’t lend me cash to settle my debts, and they won’t buy my assets (because they don’t know how much they’re worth), and so I can’t pay my bills.

If I remember right, when Lehman Brothers filed for bankruptcy, it had assets of about 125% of its liabilities, which is usually a good position to be in—but none of its assets were liquid, and it could not borrow money or sell assets, and so it had no choice but to declare bankruptcy because it could not pay its bills.

So in theory what the government can do here is lend the money to the companies itself while the whole mess gets straightened out. (Or, more likely, guarantee the loans made by other banks.) The problem is that this is what they want you to think the bailout is, while in reality it’s primarily a way to transfer yet more money to the plutocrats whose bad judgment got us in this mess in the first place.

dalepetrie's avatar

My understanding is that what scared the hell out of Bernanke and Paulson was something called “commercial paper”. Our biggest companies basically lend each other cash all the time. The idea is that at the banks, each night some companies have more cash than they need on hand, others don’t have enough. The companies borrow money from each other for short terms (like 30 days) at fairly low interest rates. This is what keeps our economy flowing, because were that to dry up, what would happen is these big companies which owe a lot of money to a lot of other companies, both big and small, would not be able to pay their bills if they couldn’t borrow the cash. These delinquencies would have an enormous trickle down effect throughout the economy. Some companies on the brink might be one step away from filing for bankruptcy and all it would take is their biggest customer saying, “I can’t pay you this month.” Companies then start to not be able to make payroll, they have to shut down and lay people off. That makes things worse. About 2 1/2 weeks ago, they saw all of these banks that write commercial paper start to lower the amount that they would issue. Maybe the biggest companies would be able to get a billion dollars before, now they can only get 1/2 a billion. Well, half a billion dollars less in borrowing power for let’s say the half of the Fortune 500 companies that need to borrow it (so 250 companies at half a billion, that’s 1.25 trillion dollars just in the 500 biggest companies, not to mention the smaller companies that can’t borrow).

It boiled down to trust as well. With banks going under and all this talk and the tightening of credit up at the top level, it was starting to trickle down quickly to the bottom level. Even people with excellent credit were being denied things like car loans, and many are not even writing mortgages. Then there is something called the LIBOR rate, this is the rate banks loan each other money at, it’s usually based on the federal funds rate set by the Fed (2%), however banks are running scared and they’ve been charging each other 7% to borrow money, which is so high that no one is borrowing. Essentially this could have frozen up the economy.

So, banks and companies who were the quickest went in and borrowed up to their maximums so they’d have cash on hand just in case, because another problem is that if people start to lose faith in their investments (deposits), whatever form they may take, they will start pulling them out and putting their money into a safer investment (like Treasury Bills, which has started to happen so quickly that they essentially aren’t even paying an interest rate that keeps up with inflation anymore, but people don’t care as long as they don’t lose their money). Then the banks have even less cash, and if everyone wants their cash all at once, and you’ve borrowed as much as you can and you can’t give people their cash the bank fails. If the bank fails others have to pick up the slack, and of course that causes cash outlays, and stresses other banks.

The attempt was basically to put a huge sum of money into the system. They decided to do so by buying up huge sums of questionable mortgages on which they may take a loss, make a profit, or break even, depending on what the market does.

Personally the big problem from my point of view was that you could have injected that money into the system by shoring up the mortgages which went bad and set this whole panic in motion in the first place. For example, let’s say someone has a $150k mortgage, and they HAD been able to make $1,200 a month payments, but the rate reset and now it’s $3,000 and they can’t do it. They are $15,000 behind the house is going to be foreclosed on, etc. Now, if the government were instead of buying this mortgage to have a pool of money where they could say, hey, let’s pay all these late fees and arrears payments that couldn’t be made and get them back to on time, then take that mortgage and refinance it at a low fixed rate so now they are back to $1,200 a month, well not only would that one transaction inject $15,000 right into the bank’s pocket, but it would take an asset (a $150 mortgage that no one was paying on) which maybe they’d valued at 40 grand, and make it worth 150 grand again. AND people would stay in their homes. My thought was there are about 5 million residential first mortgages (that is, people where it’s their only house, they actually live in it, it’s not investment property and not a second home), and if you were to take twice that, 30 grand per mortgage and put it in a fund designed to bail out homeowners in this fashion (and require banks to refinance at a low rate once these people were back up to speed), you’d spend $150 billion (instead of $700 billion), and you’d add probably 1.5 trillion dollars to their balance sheets. That would make them more credit worthy, more flush with cash, people would borrow again, everything would be right with the world, and the taxpayer would save $550 billion. And you could recover that money by requiring payback of all those bonuses that were given to the heads of these banks that allowed all the predatory lending that led to this crisis.

Judi's avatar

Hey Dale, I hear Paulson is hiring. Have you applied yet?

Mizuki's avatar

I think we call this socialism

dalepetrie's avatar

I’m pretty sure my plan wouldn’t give as much money to the people Paulson would like to pay off. Maybe however I should go after his job when Obama throws him out on his ass.

Allie's avatar

Didn’t we pay half of the 700 billion already? And we’ll be paying the other half soon? But banks still aren’t confident. So basically, they’re just stacking our money and sitting on it with their hands under their asses, right? What the fuck, banks? Pump it back into the economy. That’s what it’s supposed to be for, right?


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