free online dating websites
dating sites
dating websites free
dating website
free dating websites
«    »

A Matter of Perspective

Posted on September 27th, 2008

By now, you probably would have heard of the $700 billion bailout package being proposed by the Federal Reserve and the Treasury here in the US. (If you haven’t, the proposal is for the government to purchase illiquid securities from financial institutions whose values are not well-defined and whose value may continue to decline if homeowners continue to default on their loans. It is, obviously, much more complicated than this and there are tons of articles floating around the Internet that would probably do the problem a bit more justice.)

Whenever the government spends, though, the taxpayers are the ones who ultimately foot the bill. And here lies a central question to the proposal: should the taxpayers pay for the missteps and problems created by the financial industry? Clearly, $700 billion is a lot of money and you can imagine the polarization being caused by this.

Let’s imagine what could happen if the proposal does not go through. On paper, these assets are not particularly valuable (many have argued that banks are carrying these securities well below market value because of strict accounting rules), so banks have a limited amount of capital. This means that banks could be more reluctant to give out loans (which are essential for businesses and individuals alike), unless they felt confident that they could get the money back and with a good return. As a result, there could be even less money exchanging hands and the economy could continue its turbulent slide. So, the taxpayers would not have some questionable assets to worry about but, instead, may have to worry about their jobs and about mounting financing problems. The picture is bleak to say the least.

If the proposal does go through, then there are a couple of possibilities. The government could manage to sell the securities after the markets rebound and make a profit. This would make the government look brilliant and will come as a huge relief to taxpayers. Or, the government could take a loss and, eventually, the taxpayers will feel a pinch. The question becomes, then, at what price should the government pay for these troubled securities?

Suppose that the government low-balls them and offers pennies to the dollar. This would protect the taxpayers, but will not provide enough capital to the banks that are responsible for making loans and creating liquidity in the markets. And if the government pays a handsome price, taxpayers will likely lose out since the government will have a harder time turning out a profit.

It is quite a challenging problem. There are a lot of smart people at work trying to find a solution. (Isn’t it ironic that a lot of smart people were responsible for creating this mess?) I feel that there will definitely be a bailout, and the heart of the matter is the price at which the government will buy the securities, and what sort of conditions (like limited executive pay) will apply to firms who take advantage of the offer. To leave the markets the way they are would be extremely irresponsible and will jeopardize the short- and long-term growth of the economy. I also think that the government will pay a good price for the securities; if the government were to be cheap, it really wouldn’t be injecting much money into the economy and that would not help the situation much at all.

I should mention that this is not the first time that the government has intervened (again, at the taxpayers’ expense) in the financial markets. (The US government did it for Continental Illinois Bank in 1984, and for the airline industry in 2001. Oh yeah, and let’s not forget Freddie Mac and Fannie Mae. Or Bear Stearns. Or AIG.) I should also mention that this will not cost the government $700 billion; that will only be the case if the government does not attempt to or is unable to sell any of the securities it buys. That’s like buying a 70 billion lottery tickets and winning nothing.

Chances are that you will find yourself on one side of the fence. (It’s hard to say that the government should maybe bail out the troubled financial institutions.) What is it going to be?

One Response to “A Matter of Perspective”

  1. abid Says:

    I was against this up until today when they came up with the final statement for the plan. I think its reasonable as it stands. Giving the government an equity stake is probably the best means to offset that amount.

    On my part, I did not like how Paulson and Bernanke jumped on this thing and how quickly they wanted to rush it through.

Leave a Reply