Why *You* Need the Bailout

I have to keep this relatively brief because I have an insane day at work today, but I wanted to give a brief heads-up to some people who have questioned why I have been so strongly in favor of the bailout. Many of our commenters seem to be misinformed about what the bailout is intended to fix, where the money is going, what the final price tag will be, and what the consequences of not passing the bailout will be.

First, and perhaps most important, the price tag on this bailout is not $700B. That’s an initial capital outlay – and the Treasury Department might not even use the entire $700B as capital outlay. The money is not going directly into the coffers of Wall Street firms, it is being used to purchase securities for which there currently is no market. As Megan McArdle has been painstakingly and repeatedly explaining over and over again for the last two weeks, the value of these securities is not actually zero, or close to zero. In the absence of a panic, they have marketable value. As our own Blackhedd has explained, the key sticking point here is the valuation Treasury is going to make of these securities at purchase – that will basically answer the question of whether this bailout has the possibility of actually making money as Treasury claims. However, there is literally no case in which the government will shell out $700B for these securities and get nothing back. It simply won’t happen.

More below…

Second, contra Thad McCotter and others who are demagoguing this issue, the government is not going to drive $700B in cash to various Manhattan locations in Brinks trucks to fund Wall Street salaries. Securities are being purchased with this money – securities that will be resold when the market corrects itself.

Third, I suspect that most people don’t fully understand the dynamics of what is happening here. Imagine that downtown Manhattan is ground zero for the financial equivalent of a nuclear blast (it is). A lot of people throughout the country seem to feel that since they’re outside the area where sand is going to be turned into glass, they are safe from what’s going to happen. Nothing could be further from the truth. As has already been explained, consumer credit (including mortgages and car loans) are already about to be much harder to come by. But that isn’t the worst part of what’s happening and what is about to happen. Let me tell you about some things that I have noticed over the last few days:

  1. The commercial paper market has completely dried up. Now, three or four years ago, I didn’t have anything but the vaguest understanding that any such thing as a commercial paper market existed. But it does, and it’s vital to the orderly function of our economy. See, when businesses purchase the supplies and inputs that make their companies run, they almost never pay cash. Your local T.G.I. Friday’s receives a shipment of produce from the good people at Sysco, who hand them an invoice that says “Net30” or “Net60” on it. This invoice then gets forwarded to T.G.I. Friday’s corporate office and a bean counter somewhere cuts a check for all the food invoices within 30 or 60 days of getting the invoice. Meanwhile, Sysco has a piece of paper entitling them to payment from T.G.I. Friday’s within 30 or 60 days – in effect, they’ve extended short term credit. But this is okay for them because they can generally either sell the commercial paper at face value or very close to it, or the paper can be used as collateral to secure short-term financing. If this paper stops moving (and it’s already stopped, for reasons that I can only chalk up to a crisis in confidence), then the short-term credit that businesses extend each other that allows an economy as large as ours to function is going to stop and the disruption to the economy is going to be catastrophic. Let me repeat that for emphasis: catastrophic. And it will not matter what line of work you are in, you will feel the effects when companies shut down left and right.

  2. Virtually all companies rely on lines of credit with financing institutions to ensure an orderly flow of capital to level out the inevitable peaks and valleys that come with operating a business. These lines of credit are basically what allow your company to keep paying you during the inevitable periods of time that your company runs in the red. If the credit markets freeze much worse than they are now, significant numbers of companies will be immediately unable to make payroll. Average, everyday workers who are far, far away from Wall Street or anything connected to it will suddenly have interruptions in being paid. You can imagine the disruption to the economy that would cause. Some companies will simply not be able to survive the tightening and will fold altogether. Unemployment could reach well into the double digits.

  3. We haven’t even touched what happens if there’s a run on hedge funds or similar event within the next week and lots of margin calls can’t be met. If you got hacked off by the AIG bailout, you’re really going to hate what happens in that eventuality. It’s not outside the realm of possibility that the NYSE could face an emergency shutdown, among other delicious possibilities.

The bottom line is that the consequences of the “no bailout” plan all add up to Depression with a capital, 20-point font “D”. It will furthermore almost inevitably result in the government being on the hook for a lot more than $700B in risky assets. We are looking, at this point, at trillions and trillions of dollars in potential losses across the economic system.

No, the bailout will not completely prevent bad things from happening to the economy. THere are players in the picture that are simply not solvent and that need to be absorbed and/or cut up into pieces and sold. But the bailout will allow this to happen in an orderly fashion that does not take the United States economy down with it. Basically, it’s the difference between the late 80s and the mid-30s.

I finally took a look at the House GOP “alternative” plan last night, and the best thing I can say about it is that it is not a plan hatched by serious people who intend that anything actually be done. The plan basically has two parts – First, a whole bunch of bullet points that basically amount to “tax breaks.” Now, I’m a huge fan of tax breaks, but tax breaks in this case are not going to provide the necessary liquidity to unfreeze the credit markets. Furthermore, you, the House GOP, went and ruined your reputation with the American people and so you don’t control the show anymore. Get that? Anything you want to pass has to get by the Democrats. So, you know, what a brilliant idea, trying to ram through a “plan” that basically amounts to “tax cuts for the rich.” The only way you could have proposed a plan less likely to pass would have been to propose that we fix the economy by amending the Constitution to outlaw abortion. Second, the plan includes 100% insurance against default, which not only has no chance of passing, but also no chance of working. Have you ever tried to sell someone who can’t pay their bills insurance against not being able to pay their bills? That’s a genius idea. Furthermore, the entire problem right now is that the market has no way of transferring the risk associated with a given class of assets. So… your solution to that is to inject a risk allocation device (insurance) into that same market?? Again, this is not a proposal put forth by serious people.

If you get the idea that I’m somewhat steamed right now, I am. I live and work fairly far from the epicenter of what’s going down, but I understand the concept of fallout, and I have no idea at this point how my family and I are going to avoid it. And in the face of potential impending disaster, a group of allegedly serious people are throwing snits because of speeches they didn’t like, throwing snits because their precious Congressional sensibilities have been offended, and pretending all of a sudden (after 4 years of demonstrative evidence to the contrary) that they have principles against spending (which in this case is actually capital investment). Make no mistake about it, I am taking down names of the people who are trying to take the country down in a vain hope for good press, and in the process taking down the Republican party even further when the American people start feeling the effects of the depression and remember which party spent this vital week posturing for the cameras. You see, the Critters can afford it because they get paid by the Government and are thus insulated from the effects on the private sector that they are allegedly trying to protect – if everything goes boom in the next month, they’re fine unless they get kicked out of office. For my part, if everything does go boom, I am going to do everything I can to make sure that they get the opportunity to try to find private work in the environment they have helped to create.