Oct 01 2008
700 Billion Dollar Bailout
I would like to think I have a reasonably good understanding economics and finance. I am not specifically educated in this area but I have read a number of books about the subject. I am open to being called a niff or simpleton here if someone can explain in full how this bailout works other than what follows.
My real thoughts on this bailout are; what does all this money actually achieve?
My understanding is that the US Government will raise 700 billion from their ability to lay tax on the citizens of the USA. They will then have the US Federal Reserve (who are owned by private corporation ‘member’ banks – remember this) to create this money. Once this money is created (no it is not sitting in some vault somewhere) the government will purchase or insure 700 billion dollars worth of troubled mortgage backed securities.
Mortgage backed securities are the crux of this issue. These little beauties are only as good as the people who create them or loan them. In very basic terms if you, Joe Homebuyer, wants to buy a home or commercial property. You go to a bank to borrow money from them to buy said property. They lend you lets say for example $100,000 for this property. Now in essence the bank owns the property and will get interest from you every month to pay for this property.
The bank may have thousands of similar loans that they carry on their books and are at risk too. So they bundle these loans together (with the help of Fannie May or Freddie Mac) and they sell these loans as a ‘mortgage backed security’ (lets call them MBS’s from now on) in a form very similar to a bond. The people who buy these MBS’s vary from super funds to investment banks to anyone really but the major purchaser of these MBS’s is a little group of investment banks that seem to be in trouble at the moment.
So what is causing the issues here?
One problem is the loaning practices of the people lending the money in the first place has slipped greatly in recent years and a lot of the Joe Homebuyer’s out there can’t afford these loans. The people lending money haven’t effectively screened their clients to make sure he or she can afford what they are trying to buy. In the end Joe Homebuyer struggles along for a period and eventually succumbs to the pressure and defaults on the loan.
Not a problem you think, the MBS’s owner still owns the property? True but what happens when there are thousands of defaults and thousands of extra homes/properties available for sale? Well the old simple rule of supply and demand comes into play and the value of these ‘securities’ starts to drop significantly. Suddenly the MBS owner is not getting his interest anymore and the value of the security is dropping, bad darts in anyone’s language.
The second problem is that these investment banks that have bought the majority of these MBS’s have been able to borrow money against them. Yes, they have a security that they ‘sort’ of own and they are able to borrow heavily against it to buy, well, whatever the hell they want to!! And what happens when you borrow against a security that suddenly starts to drop in value? Welcome to house of cards, population investment banks.
Back to my original question, what does this all this money actually achieve?
The government will have the US Federal Reserve (A private corporation remember) create this money to buy these troubled MBS’s from a bunch of investment banks. The concern is that more than likely a large percentage of these investment banks are also the same owners of the member banks that own the US Federal Reserve. You can see how this could look bad to a lot of people and may explain why this wasn’t voted through this morning.
Certainly raises some questions as to private ownership of the Federal Reserve! I always assumed it was government owned, but never really checked it out.
Raises the question who owns the RBA??
You could almost say this was orchestrated by the US Federal Reserve by dropping interest rates to 1% making credit cheap for those who can’t afford it…..that’s where the whole thing started. And we now know who owns the Federal Reserve thanks to SJ.
Simpleton summary:
- US Federal Reserve drops rates to 1%
- Credit become cheap and sold to bevans to buy big caravans
- Debt sold to men in suits from investment banks for their portfolios
- US Federal Reserve increases interest rates
- Bevans cut back on smokes & Miller Draft but still can’t make repayments…..default on loans
- Home prices start to fall and bevans kicked out of their luxury trailers
- Suits lost money – now buying burger king quad stack burgers for lunch rather than altantic salmon
- Head banker, now in a cheap suit, asks US Federal Reserve to ‘create’ more money to buy the debt from the banks. Market celebrates
- Congress say NO MONEY FOR YOU!!!! If you own the Federal Reserve, you can’t just ask it to create some cash for you when you need it. Market tanks.
Good post SJ!
I’m with Velcro SJ, excellent post. I must admit to having no more than a topline understanding of this situation, so congratulations on giving a more detailed explanation and no doubt encouraging more discussion throughout the day.
IASM, I believe this is one of the areas in which you profess to be an expert?? If so, please enlighten us further.
No doubt I’m inviting ridicule here, but isn’t there also the issue of inflation caused by throwing an additional $700 billion $1 bills into the market??
with any luck IASM.com jumped off a building yesterday
don’t tease us Woody!!
I doubt the information you mentions about the US Fedural Reserve being owned by private companies is true.
But if it somehow is true then I am sure there is a lot more to it then the basics you have explained here. Once again I would take on trust what people who are directly involved in this would have to say a little more than your theory on it.
I would like to read a description from someone telling us more information and detail about exactly what this bailout involves.
No sign of Mr Desperate & Dateless today…..maybe Woody was right!
Did you push him Woody??
If he did there isn’t a jury in the land that would convict him of any wrongdoing……
Interesting read. I didn’t really understand what the baleout was but this seems to make sence to me.
I hope it isnt true that the Fedral Reserv is owned by the same banks in trouble. That would be a little concerning.
Background info – the subprime primer
http://docs.google.com/TeamPresent?docid=ddp4zq7n_0cdjsr4fn&skipauth=true&pli=1
“I would like to think I have a reasonably good understanding economics and finance.”
I have a sore stomach from laughing at that opening statement SJ!! The collective understanding of this topic (with the exception of myself & possibly the rabbit) is frightening!
(I know nothing, I didn’t write the stick figure primer or anything)
Good to see you expressing your intelligence SJ, you’ve got me convinced.
IASM, we all know you well enough to know that if you knew anything about this topic you wouldn’t have been able to hold back from lecturing us in detail (in actual fact you were even invited to enlighten us by both SJ and myself).
Grow up like the rest of us and admit you don’t know it all.
What is concerning me the most, is that the fat cats got it wrong after making millions upon millions for years and now when the poo hits the fan, they want the Gov to bail them out. Does the Gov go around bailing out failing businesses on a daily basis? Maybe I could start a failing bank and get a handout.
refinancing home loans in arizona…
It used to be that when you bought a home and didn’ t have a twenty percent down payment lying around, you had to pay what is known as private mortgage insurance (PMI). PMI is insurance that the lenders requires borrowers to pay to insure that the lend…