Sunday, September 21, 2008

Ah, What A Mess

I don't have much time for a post today so this one is going to mostly be posing a question for everyone to ponder for the remainder of the weekend. Feel free to post your thoughts on the matter below. 

On Friday, President Bush announced that he wants congress to pass a 700 billion bailout of the financial markets. The basic idea is that the government will buy all the bad loans and mortgages that banks have on their balance sheets from homeowners defaulting on their loans. Most analysts agree that if all of these bad loans were taken off the hands of the banks, then they would once again be able to turn a profit.

There are two key points to notice here. First, when Bush says the government is going to use 700 billion to buy these loans, the government doesn't just print more money, it has to generate it from somewhere. To raise this amount of money, it can do three things. One, it can raise taxes to cover the cost (very unlikely in this case). Two, it can cut current spending levels in social programs or a war effort to off-set this new cost (again very unlikely in this case). Three, it can take very high interest foreign loans to finance the deal (most likely option). In essence, this last option is how the Bush administration has financed the wars in Iraq and Afghanistan without raising taxes at home. The take home point is the money doesn't just appear, it has to come from somewhere.

The second point to note is that there is another way to solve this crisis that hasn't been discussed. The Bush plan focuses on saving the banks, but does nothing for the home owners who have these loans. A viable alternative would be to have the government either help homeowners make their payments, or restructure of all floating loans that have been made in the last five years to fixed rate loans with affordable monthly payments (i.e. lower fixed interest rates and perhaps extending payment periods beyond 30 years) so that people can make their payments. The effect would be that banks would not be making big profits (and perhaps might even be taking small losses as opposed to their current huge losses), but they also would be able to remove the bad debt off their books, since payments would be coming in. 

So, the big question is which plan is better? I personally come down on bailing out homeowners over bailing out banks, or at least having a combination of bailing out both.  The idea that only the banks should be bailed out with my money seems both morally wrong and financially unsound. I completely agree with idea that these banks can't simply be left to fail. They are too integrated into the financial system. However, that doesn't mean the solution to the problem has to let the banks completely off the hook, while individual homeowners get nothing and are led to financial ruin themselves. It seems to me if you are going to use taxpayer dollars to solve this problem that the solution better address both sides of the crisis. 

In the end, the question comes down to who should get rescued: the banks, the homeowners or both? Both banks and homeowners are guilty of greed and have both made mistakes, but why should only one side get bailed out?

1 comment:

Anonymous said...

Even if the banks are bailed out along with the homeowners, there should be a cap on golden parachutes now and into the future for CEO's.