Wednesday, September 24, 2008

Political and Financial Bailout

Today Senator John McCain said he would suspend his campaign and return to Washington to work on the Wall Street bailout plan on which Congress is currently working. He also stated that he would work with Obama to make a joint statement delaying the debate on foreign policy this Friday in Mississippi. McCain said that the urgency of the situation requires that he and Obama put the campaign aside and go to Washington until the bailout is passed.

Obama later went in front of reporters to say that he and McCain had talked earlier that day - apparently Obama's campaign called McCain after Senator Coburn (R-OK) suggested it would be a good idea to give a joint statement - and their campaigns agreed to make a joint statement. Obama expressed his surprise at McCain's statement regarding the suspension of his campaign and a delay in the debate as Obama thought their campaigns would work on a statement before they went to the press.

McCain and the Republicans are saying that he is being bipartisan and that he and Obama are so needed in Washington that the debate can't go forward. On the other hand, Obama and the Democrats are saying McCain is attempting a cynical political move to delay the foreign policy debate - one he has the most likelihood of winning in the eyes of Americans - which would otherwise be lost in the turmoil of the financial crisis.

Regardless of either candidate’s political motivations, the economic crisis is extremely serious at the moment. McCain may have political reasons for wanting to delay the debate and suspend campaigning, but there is a legitimate reason why he and Obama will be returning to Washington soon and why they may even stay through the weekend.

Since financial institutions on Wall Street began to fail, starting this spring first with Bear Sterns and most recently with AIG, the financial system has been deflating. Bear Sterns Treasury Secretary Henry Paulson has been talking about governmental measures similar to taking out "bazooka" to reassure investors; by this he meant governmental intervention disproportionate enough to the problem to reassure investors such that money continues to flow into the credit markets. However, the size of the AIG failure, the lack of a recovery in the housing sector, and the constant stream of bad financial news has spooked investors to such an extent that massive government intervention is necessary to restore investor confidence.

It may seem odd to the average person that our markets are suffering from a lack of confidence; after all, business people and economists deal with money and numbers, things that have value and are absolute. Unfortunately, the market (and economics in general) is more of an experiment in social science and psychology than anything else. Value on the market is assigned by what people are willing to pay for something based on their needs and wants. When a major crisis like the collapsing housing market occurs, no investor is willing to buy a bad investment (such as a subprime mortgage backed security). This makes it difficult to value anything in the market, but it is widely known that those securities are dropping in value. Goldman Sachs and Morgan Stanely, the only significant investment banks left in existence, have been given a free pass to become regular banks in order to gain the greater security that comes with government regulation of that sector of the economy.

Investors are seeking to find the safest possible investments and hold back on lending, thereby freezing up the credit markets even for good borrowers and sound investments. Franchises of McDonald's are now finding it hard to get credit to repair their restaurants, and GM is taking out all the credit it has left for fear of not being able to find cash later. Businesses need access to credit to expand, but they also need it to pay the bills when they have no cash on hand. So not only will the economy not expand, it may contract once businesses start going under after they can't afford to pay their bills, and more importantly their employees. Even individuals with good credit may not be able to get loans for new homes, cars, or higher education tuition.

Secretary Paulson and Federal Reserve Chairman Ben Bernanke believe the situation after the AIG fallout to be so serious that they think the government must intervene and buy the bad mortgages - at a discount as they are so low in value right now - so that financial institutions can pay off their debts and prevent the credit markets from freezing up. However, the political problem here is that this will be an unprecedented bailout of incredible size. Americans are used to hearing billions of dollars being spent, but $700 billion is a massive amount of money. To put this in perspective, the Iraq War has cost $550 billion from its start through August 2008 and the entire budget for 2007 was $2,730 billion ($2.73 trillion).

Paulson and Bernanke believe that this bailout must be passed by next week or the credit markets will freeze. So far, many financial experts seem to agree. Experts also believe that this may not be a losing proposition to Americans, as the assets that are purchased - U.S. mortgages backed securities owned by U.S. or foreign financial institutions - will eventually rise again after institutions are relieved of their bad investments and credit markets begin to flow regularly again. If there is a loss, it won't be the full $700 billion, but there could be a $200 billion loss or even a $200 billion gain.

The key to the current bailout plan, and the reason McCain wants to claim a need to suspend debates, is the need for a speedy government reaction to stop the credit markets from freezing. So far, Republicans have been the more resistant to a bailout because of their faith in the free market and dislike of government spending or intervention. Regardless of what either candidate or party says, the politics of this crisis and the election will always be a major consideration in any decision that has to be made. Fortunately for Americans, both candidates and a majority of Congress agree with the Administration that bailout plan must be passed within the week. Hopefully this will be a big enough "bazooka" to stave off economic collapse such that future intervention of this scale will not be needed.


pme said...

Slow down, money?!

What are the (perhaps longer term) consequences of a $700 billion bailout for the inflation rate, the dollar, oil prices and foreigner's confidence in US-bonds and in other dollar denominated assets? I am not entirely convinced this deal needs to be rushed through, in such a - blank check ... just sign at the bottom ... no need to read the fine print - manner.

R.P. McMurphyDBB said...

I would agree with you, which is why I think you are going to see that the final bill has an incremental release of the 700 billion. The basic idea that we give the markets enough (say 150 billion) to offset short term confidence, then work with the next president to solve the systemic problems while providing additional support as needed.