Saturday, October 04, 2008

Your Birthday Comes Around Once A Week And It’s Christmas Every Day

Editors note: my lack of recent posting has been due to my involvement in an intense blogger mentoring program. I have been following a noted national blogger around, taking notes and trying to improve my game. It has been a priveledge to be taken under his wing. Although he probably wouldn't want to be named here, let's just say his name rhymes with Schmed Horrisy. Anyway, my mentor has worked with me to enhance my writing to the point where I can pen this ever so serious piece on the recent $700 million bailout of the American financial sector.

The bailout is a strange animal. It doesn't fall along partisan lines. George W. Bush, Barak Obama and John McCain all supported it. Reliable conservatives like Michelle Bachmann and John Kline had a rare disagreement over it. On the liberal side, Keith Ellison supported and Tim Walz opposed.

It seemed like the base opposition to the bailout came from the conservative side of the Republican party, good hearted folks like Rep. Bachmann. Their logic is that the bailout is government interference with the free market. Interestingly, they were joined by some bedwetting lefty weenies like Dennis Kucinich and crooks like William Jefferson, who objected on the grounds that allowing the economy to crash would harm rich people and folks that wouldn't give them bribes.

So where do you go to determine the truth on an issue that reliable conservatives disagree upon. Obviously, the Nihilist in Golf Pants. For more on the subject, I recommend read King Banaian's thoughts here. King is a sharp guy and I generally agree with his take on the topic. However, his column is more a defense of how the free market didn't create the conditions we are in now as opposed to commentary on whether the bailout was a good idea. I shall now explain why it was. Be warned, this is pointy-headed stuff, so if you don't like economics, go look at some internet porn.

I am not suggesting that the bailout was a perfect solution or even desirable. With better regulation of Fannie and Freddie, with Barney Frank in some bathhouse as opposed to in congress, this unfortunate situation may have been avoided. However, given the situation we needed to pass this bill.

Why? Because the banking system must not fail. Today we have a situation where many banks bought assets called mortgage backed securities. Think of them like a bond. You buy them and get paid interest. Recently, some of these bonds began to default. It looks like the banks paid too much for them. Again, I am not going in to the reason that this happened, but it did indeed happen.

So now we have a bunch of banks whose asset values have dropped a lot and other banks who were good citizens and had their asset values drop a little.

It is a fact that cash management is important to the business of banking. Put another way, every day every bank in the world needs to match up their assets (lending) with their liabilities (deposits, borrowing and reserves.) The Federal Reserve helps do this through the Fed Funds Window. The Fed Funds Window essentially provides overnight loans to the biggest banks in America. Those banks then lend overnight to smaller banks.

Over the last two weeks, smaller banks faced an increasingly difficult time borrowing from larger banks. The reason is that the larger banks couldn't tell if the smaller banks had plunging asset values or not. Credit began to freeze up. Many banks that had trouble getting funds were still in good shape. That is, until they couldn't get the funds they required to operate.

The bailout allows the government to purchase the impaired assets of banks, likely at a discount. Thus, the larger banks now can believe that the smaller banks assets are true and therefore will be more comfortable loaning to them. This will allow the small banks that are good citizens to avoid being punished as if they had risky bonds on their books.

Many have argued that the bail-out is giving money to rich capitalists that invested in corrupt or poorly managed companies. But a look at the stock prices of the companies in the headlines quickly discredits this. AIG, which has already been bailed out, is trading under $4 per share. Less than a year ago it was trading at $70. Fannie Mae and Freddie Mac had traded over $50 within the last year. Now they are both below $1.50. Wachovia Bank, which will be bought by Wells Fargo as opposed to a federally brokered deal with Citigroup, fared slightly better. They are down from $50 to under $7.

The shareholders of all these beleagured institutions have lost nearly all their wealth. We don't need shareholders and employees of better institutions beat up because of a frozen credit market.


Anonymous Anonymous said...

I'd rather read the nihilist's "An american Carol" review

12:12 PM  

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