What are the consequences if $700bn bailout doesn't work?

[z106]

Just so I am clear here - the US tax payer is giving out $700bn (apparently $2,300 per head in the US) to the banks so they will have more liquidity which they hope will stimulate the economy yes?

So - what are the consequences if this doesn't work?

Also - what is the alternative to this option that they are discussing right now?

 

[theoneill]

I'm not sure it will buy anything other than time.



But I am of the mind that if the directors and shareholders keep all the profit they should also shoulder all of the loss. However if some of the largest financial institutions fall I reckon the fallout will be wide-ranging and painful. It’s a kinda catch 22 situation.

 

[Protocol]

The plan is to spend 700bn USD buying loan assets from banks.

So the govt would buy bad debts from banks, at less than face value.

The banks would be relieved of these "toxic assets" and so their balance sheets would be stronger.

The banks would then restart lending to each other, and make credit easier to get overall.

The State would acquire 700bn worth of mortgages, which it may later sell on to other banks, or to anybody else.

The State hopefully would not losw too much on the deal.

 

[jhegarty]

Actually I think the plan is the government to make a profit (presuming it all works)

 

[Towger]

The State would acquire 700bn worth of mortgages, which it may later sell on to other banks, or to anybody else.

The State hopefully would not losw too much on the deal.

What is the definition of these "toxic assets"? Are these the mortgages which have already gone bad and no hope of recovery or those which looking back would now be classed as Sub Prime?

If the later the State could turn around and change the laws, making it harder to hand back the keys and walk a way. There are reports that in a large number of cases people can still afford to replay the mortgages, but the houses have dropped so much it makes more financial sense to just walk a way.

 

[Sunny]

Just so I am clear here - the US tax payer is giving out $700bn (apparently $2,300 per head in the US) to the banks so they will have more liquidity which they hope will stimulate the economy yes?

So - what are the consequences if this doesn't work?

Also - what is the alternative to this option that they are discussing right now?

The consequences don't even bear thinking about. I will be accused of being melodramatic but you could see the collapse of the US banking system and by extension the world's financial system if something isn't done. As far as I know there is no real alternative. I think they all agree on the basics but are arguing over the details that get put into the law.

Personally I would have doubts whether this plan will even work but they have to do it. I don't see it curing American Banks liquidity and Capital problems There is not enough detail to really comment on it especially on how they intend to price the assets that they are intending to buy and I also would question whether $700 billion is actually enough as scary as that sounds.

 

[z109]

There are some serious inconsistencies in the plan. It proposes to buy Asset Backed Securities (not just mortgages, but auto-loans, student loans, credit card debt) at above market rates posited on a hold-to-maturity rate being higher. This seems to me to be nonsense - the market has prices these ABS at the rates they are at to hold-to-maturity level - that is what markets do, price the value of something.

So in effect, the Fed Reserve will be buying ABS at above market level from certain institutions. This will result in two prices for these assets, the Fed price and the actual market price. If you cannot sell to the Fed, you have to sell to someone who can. They can then make a profit on turning around and selling to the Fed.

As has been pointed out by a number of US senators and 190 US economists, this benefits only those banks who will be the conduits for this. All other banks - the banks that do the financing of main street, as opposed to Wall St., will take their lumps as will the US taxpayer.

700 bn is also a drop in the ocean. Jut on mortgages: 3.2 trillion of US mortgages were securitized in the last few years (I believe). The value of those mortgages is likely to fall 35-40% if house prices in the US revert to long-term trend. This indicates that just the mortgages of the last few years will incurr losses of 1-1.2 trillion. And that is before all the other ABS is considered.

Add to this, it does nothing to help the consumer in the US - the root cause of the problem is that Americans are up to their oxsters in debt. 70% of the US economy is consumption, so without doing something to fix the spending power of the consumer, there is a dramatic realignment of the US economy about to take place.

 

[Sunny]

Add to this, it does nothing to help the consumer in the US - the root cause of the problem is that Americans are up to their oxsters in debt. 70% of the US economy is consumption, so without doing something to fix the spending power of the consumer, there is a dramatic realignment of the US economy about to take place.

Another point related to US debt that I have been discussing with other people is that after all these bailouts, is there anyway that the US can keep it's AAA rating. I know the agencies are looking at it but I seriously doubt they would be brave enough to downgrade them. As a foreign investor, the appeal of US assets is dwindling fast. Never mind the effect this plan will have on the $. I heard Bernanke speak at the Congressional hearing on the subject saying the US credit was still considered good as can be seen by low yields but wouldn't directly answer the question on the rating. Right now, people are focused on this plan and getting it through congress. Once it is passed the attention is going to switch to the effects that it will have on the US. We will see where yields and the dollar are then!

 

[room305]

Just so I am clear here - the US tax payer is giving out $700bn (apparently $2,300 per head in the US) to the banks so they will have more liquidity which they hope will stimulate the economy yes?

So - what are the consequences if this doesn't work?

Also - what is the alternative to this option that they are discussing right now?

According to Bernanke and Paulson, there is no alternative except bailing out their banking buddies. Which is to say they haven't proposed an alternative. Of course there's an alternative - let the banks sink. It's just Bernanke and Paulson don't want to even consider it as an option.

Every American I have spoken to is infuriated by the proposal.

Few remember Goldman Sachs funneling their vast profits to the taxpayer when times were good.

Senators, regardless of party affiliation, are torn in two directions. On the one hand, they have Paulson putting the strong-arm on them unless they vote for the bill and yet they are unable to ignore the fact their constituents are screaming for them to vote against it.

If it were me I'd say let the banks collapse, as there is every possibility the US government could blow the money and have the banks collapse anyway. The $700 billion would be better spent picking over the carcass afterwards.

There are some serious inconsistencies in the plan. It proposes to buy Asset Backed Securities (not just mortgages, but auto-loans, student loans, credit card debt) at above market rates posited on a hold-to-maturity rate being higher. This seems to me to be nonsense - the market has prices these ABS at the rates they are at to hold-to-maturity level - that is what markets do, price the value of something.

So in effect, the Fed Reserve will be buying ABS at above market level from certain institutions. This will result in two prices for these assets, the Fed price and the actual market price. If you cannot sell to the Fed, you have to sell to someone who can. They can then make a profit on turning around and selling to the Fed.

As has been pointed out by a number of US senators and 190 US economists, this benefits only those banks who will be the conduits for this. All other banks - the banks that do the financing of main street, as opposed to Wall St., will take their lumps as will the US taxpayer.

700 bn is also a drop in the ocean. Jut on mortgages: 3.2 trillion of US mortgages were securitized in the last few years (I believe). The value of those mortgages is likely to fall 35-40% if house prices in the US revert to long-term trend. This indicates that just the mortgages of the last few years will incurr losses of 1-1.2 trillion. And that is before all the other ABS is considered.

Add to this, it does nothing to help the consumer in the US - the root cause of the problem is that Americans are up to their oxsters in debt. 70% of the US economy is consumption, so without doing something to fix the spending power of the consumer, there is a dramatic realignment of the US economy about to take place.

Excellent post. As Mike Shedlock has been pointing out in his campaign against this bill, the American taxpayer will not see one additional job created in return for the $700 billion.