What does $400 billion get you these days?
September 26, 2008 6:01 AM Subscribe
EconomyFilter: So I get that Congress is debating a 700 billion bail-out measure and things are contentious between the republicans and democrats. But what I can't seem to find out is...
EconomyFilter: So I get that Congress is debating a 700 billion bail-out measure and things are contentious between the republicans and democrats. But what I can't seem to find out is...
-- just what is that money going to be used for?
-- how would using the money in that way be helpful for the economy?
-- what exactly would happen that's so very horrible to the american citizen (that hasn't happened already) if there is no bailout at all.
EconomyFilter: So I get that Congress is debating a 700 billion bail-out measure and things are contentious between the republicans and democrats. But what I can't seem to find out is...
-- just what is that money going to be used for?
-- how would using the money in that way be helpful for the economy?
-- what exactly would happen that's so very horrible to the american citizen (that hasn't happened already) if there is no bailout at all.
The money is going to be used to buy from financial institutions mortgages and securities which derive their value directly and indirectly from mortgage cash flows, in which the market has lost confidence to buy other than by way of a government program.
This is believed to help the economy because (1) it will relieve the risk of snowballing defaults and failures from the inability to pay back the loans taken to buy those mortgages and mortgage related securities, which cripple the world financial system and (2) it will free up financial institutions to start lending to businesses and individuals again.
The fear is that the citizen (1) will find it impossible or very difficult to get a job or better goods and services because business won't be able to borrow to finance expansion or even daily operations (in companies that operate on credit), (2) will have great difficulty getting a mortgage, car loan, student loan, or maybe even use their credit cards, (3) will suffer big 401k losses due to a general economic meltdown.
posted by MattD at 6:32 AM on September 26, 2008
This is believed to help the economy because (1) it will relieve the risk of snowballing defaults and failures from the inability to pay back the loans taken to buy those mortgages and mortgage related securities, which cripple the world financial system and (2) it will free up financial institutions to start lending to businesses and individuals again.
The fear is that the citizen (1) will find it impossible or very difficult to get a job or better goods and services because business won't be able to borrow to finance expansion or even daily operations (in companies that operate on credit), (2) will have great difficulty getting a mortgage, car loan, student loan, or maybe even use their credit cards, (3) will suffer big 401k losses due to a general economic meltdown.
posted by MattD at 6:32 AM on September 26, 2008
Good questions, I'll try to take a stab:
-- just what is that money going to be used for?
Buying distressed Mortgage Backed securities. The investment banks have these things, and they've clearly lost a lot of money on them, but no one knows how much. By buying them at higher than market prices, the treasury will get them off the banks' books and infuse the banks with cash. It should also, hopefully, remove any uncertainty that the holders of these securities will go bankrupt.
-- how would using the money in that way be helpful for the economy?
The uncertainty regarding these securities is making business very risky for the banks. They're trying to hold on to as much capital as they can to stay afloat. Which means fewer loans. But loans are what powers our economy to a large extent (loans for mortgages, car loans, credit cards, business loans for expansions, etc).
-- what exactly would happen that's so very horrible to the american citizen (that hasn't happened already) if there is no bailout at all.
To hear Paulson or Bernanke the timeline goes: 1.) Congress fails to pass bailout before recess. 2.) ??? 3.) Thunderdome.
But no one really knows what might happen and when. Credit will tighten and money will become scarce. Businesses with high debt will find it difficult to operate. Banks fail. No one can buy anything on credit, which may sound fine, but that kills a lot of the economy.
posted by justkevin at 6:39 AM on September 26, 2008
-- just what is that money going to be used for?
Buying distressed Mortgage Backed securities. The investment banks have these things, and they've clearly lost a lot of money on them, but no one knows how much. By buying them at higher than market prices, the treasury will get them off the banks' books and infuse the banks with cash. It should also, hopefully, remove any uncertainty that the holders of these securities will go bankrupt.
-- how would using the money in that way be helpful for the economy?
The uncertainty regarding these securities is making business very risky for the banks. They're trying to hold on to as much capital as they can to stay afloat. Which means fewer loans. But loans are what powers our economy to a large extent (loans for mortgages, car loans, credit cards, business loans for expansions, etc).
-- what exactly would happen that's so very horrible to the american citizen (that hasn't happened already) if there is no bailout at all.
To hear Paulson or Bernanke the timeline goes: 1.) Congress fails to pass bailout before recess. 2.) ??? 3.) Thunderdome.
But no one really knows what might happen and when. Credit will tighten and money will become scarce. Businesses with high debt will find it difficult to operate. Banks fail. No one can buy anything on credit, which may sound fine, but that kills a lot of the economy.
posted by justkevin at 6:39 AM on September 26, 2008
What MattD said. I will say it again, since it took me a while to understand this stuff and I had to hear it about ten different ways before I did.
Right now, there are a bunch of securities (a type of investment) made up of mortgages. Some of these mortgages are held by low-risk borrowers, some of them are held by high-risk borrowers (the sub-prime mortgages, the mortgages created for the people with a very bad credit history). Now, as part of the housing crisis people are defaulting on their mortgages like mad, especially the sub-prime ones. That reduces the values of these securities. Problem is, nobody knows exactly how many good mortgages and how many bad mortgages are in each security. They are all mixed together--your bundle could be made mostly of good mortgages held by borrowers who have never missed a payment, or your bundle could be mostly made of bad mortgages held by borrowers who have long since mailed in the keys and left behind a gutted house that nobody wants.
Because they don't know which are good and which are bad, everyone is now assuming those mortgage bundles are worth nothing. Problem is, previously everyone thought those bundles were worth billions and billions of dollars. Everybody wanted the mortgage-backed securities, they were making so much money! They seemed like a good idea! So almost all of the banks and investment banks and whatnot are going through panics as they lose a crapload of capital because their mortgage bundles are now shit. As they spin out, the market is following them down. Nobody wants to trade with anybody, nobody wants to loan to anybody, because no one is sure who is going to go bankrupt and who isn't, and no one wants to risk losing more money. Having a freeze on the ability to get loans (this is the "credit freeze" that they're talking about) is tremendously, tremendously bad for EVERYONE, not just the banks.
What to do? Obviously, you want to get rid of these risky securities and trade them in for cash. That way you can go back to lending and trading as usual. But who would buy a whole bunch of investments that could be worth nothing?
This is where the government is stepping in. The hope is, if they buy up all of these securities, then the infusion of cash will keep the credit markets from freezing up and financial institutions will start loaning again. Investor confidence will return and the markets will stop crashing. Hooray! There will still be serious backlash, but Paulson/Bernanke is hoping it will be "Recession" and not "Thunderdome".
As for consequences, like MattD said: Imagine all of the things that have to do with banks, ever. Savings, retirement funds, checking accounts, credit cards, mortgages, loans to businesses to finance expansion, all of these things. Now imagine them gone. Poof! The money you have in the bank--poof! The money in your retirement account--poof! The mortgage contract that enables you to stay in your home despite not fully owning it--poof! That is the worst-case scenario we're looking at here. A Great Depression on steroids.
posted by Anonymous at 7:01 AM on September 26, 2008
Right now, there are a bunch of securities (a type of investment) made up of mortgages. Some of these mortgages are held by low-risk borrowers, some of them are held by high-risk borrowers (the sub-prime mortgages, the mortgages created for the people with a very bad credit history). Now, as part of the housing crisis people are defaulting on their mortgages like mad, especially the sub-prime ones. That reduces the values of these securities. Problem is, nobody knows exactly how many good mortgages and how many bad mortgages are in each security. They are all mixed together--your bundle could be made mostly of good mortgages held by borrowers who have never missed a payment, or your bundle could be mostly made of bad mortgages held by borrowers who have long since mailed in the keys and left behind a gutted house that nobody wants.
Because they don't know which are good and which are bad, everyone is now assuming those mortgage bundles are worth nothing. Problem is, previously everyone thought those bundles were worth billions and billions of dollars. Everybody wanted the mortgage-backed securities, they were making so much money! They seemed like a good idea! So almost all of the banks and investment banks and whatnot are going through panics as they lose a crapload of capital because their mortgage bundles are now shit. As they spin out, the market is following them down. Nobody wants to trade with anybody, nobody wants to loan to anybody, because no one is sure who is going to go bankrupt and who isn't, and no one wants to risk losing more money. Having a freeze on the ability to get loans (this is the "credit freeze" that they're talking about) is tremendously, tremendously bad for EVERYONE, not just the banks.
What to do? Obviously, you want to get rid of these risky securities and trade them in for cash. That way you can go back to lending and trading as usual. But who would buy a whole bunch of investments that could be worth nothing?
This is where the government is stepping in. The hope is, if they buy up all of these securities, then the infusion of cash will keep the credit markets from freezing up and financial institutions will start loaning again. Investor confidence will return and the markets will stop crashing. Hooray! There will still be serious backlash, but Paulson/Bernanke is hoping it will be "Recession" and not "Thunderdome".
As for consequences, like MattD said: Imagine all of the things that have to do with banks, ever. Savings, retirement funds, checking accounts, credit cards, mortgages, loans to businesses to finance expansion, all of these things. Now imagine them gone. Poof! The money you have in the bank--poof! The money in your retirement account--poof! The mortgage contract that enables you to stay in your home despite not fully owning it--poof! That is the worst-case scenario we're looking at here. A Great Depression on steroids.
posted by Anonymous at 7:01 AM on September 26, 2008
May I ask a followup/piggyback question?
Why doesn't anyone seem to know how much these bundles are worth? Granted, investors sometimes buy into a security without full information. But if people didn't know before, you would think that at least now someone (who? the banks? whoever bundled the loans in the first place) would have hordes of analysts combing through the loans to try to figure out how many of them are good. If it were the case, wouldn't an owner of one of these bundles want to be able to say, "97% of our mortgagees are up-to-date on their payments and we expect them to pay off the loan on schedule?"
posted by DevilsAdvocate at 7:42 AM on September 26, 2008
Why doesn't anyone seem to know how much these bundles are worth? Granted, investors sometimes buy into a security without full information. But if people didn't know before, you would think that at least now someone (who? the banks? whoever bundled the loans in the first place) would have hordes of analysts combing through the loans to try to figure out how many of them are good. If it were the case, wouldn't an owner of one of these bundles want to be able to say, "97% of our mortgagees are up-to-date on their payments and we expect them to pay off the loan on schedule?"
posted by DevilsAdvocate at 7:42 AM on September 26, 2008
Yeah, I have the same question as DevilsAdvocate. Isn't there paperwork somewhere, in some form that says what is in this individual bundles. If not, then what the hell? Who buys something not knowing what's in it?
posted by Brandon Blatcher at 7:51 AM on September 26, 2008
posted by Brandon Blatcher at 7:51 AM on September 26, 2008
Because the answer to that question ultimately depends on how many of the underlying mortgages go bad. And the answer to that depends on how much the economy turns out to tank. And how much the economy tanks depends on whether all the financial institutions fail. And whether all the financial institutions fail depends on what the value of the mortgage backed securities is.
posted by yarrow at 7:55 AM on September 26, 2008
posted by yarrow at 7:55 AM on September 26, 2008
I would start by reading some of the links in this earlier thread.
posted by damn dirty ape at 7:56 AM on September 26, 2008
posted by damn dirty ape at 7:56 AM on September 26, 2008
b1tr0t, Yes, "we" may make money on AIG, F* Mae, etc. but you notice how that piece goes sloppy when talking about Paulson's bailout deal? Yeah, well, the whole point of Paulson's bailout deal is to keep the FDIC et al. from making more money at Wall St. expense.
We're not looking at a total economic meltdown here. The Great Depression started when congress created, and maintained for 4 years, a liquidity crisis by deciding that margin trades were immoral and should pay much more interest. No one will be so stupid today. What can happen in modern economies is runaway inflation when foreign investors pull out.
To put it most simply, Paulson wants to save Wall St. *from* the FDIC by taxing savings. Only Wall St. bears the risks when the FDIC cleans up, but everyone bears the risk of an inflationary disaster if congress saves them.
posted by jeffburdges at 8:08 AM on September 26, 2008
We're not looking at a total economic meltdown here. The Great Depression started when congress created, and maintained for 4 years, a liquidity crisis by deciding that margin trades were immoral and should pay much more interest. No one will be so stupid today. What can happen in modern economies is runaway inflation when foreign investors pull out.
To put it most simply, Paulson wants to save Wall St. *from* the FDIC by taxing savings. Only Wall St. bears the risks when the FDIC cleans up, but everyone bears the risk of an inflationary disaster if congress saves them.
posted by jeffburdges at 8:08 AM on September 26, 2008
yarrow: but aren't there models that can account for such effects? Meteorology has feedback loops, but that doesn't make it impossible to predict the weather. Engineering has feedback loops, but that doesn't make it impossible to build a chemical plant. Granted, economics is not as tidy as engineering or even meteorology, but I don't see how that would make it impossible to estimate those values.
Or to put it another way: let's say one of those bundles, if all the mortgagees paid off their loans on time, would be worth $100 million. Can't anyone even say, "we estimate the value of this to be between $55 million and $70 million?" Seems like all anyone is saying is "it could be anywhere from $0 to $100 million."
posted by DevilsAdvocate at 8:11 AM on September 26, 2008
Or to put it another way: let's say one of those bundles, if all the mortgagees paid off their loans on time, would be worth $100 million. Can't anyone even say, "we estimate the value of this to be between $55 million and $70 million?" Seems like all anyone is saying is "it could be anywhere from $0 to $100 million."
posted by DevilsAdvocate at 8:11 AM on September 26, 2008
I think Jon Stewart called it "2000 McDonald's apple pies for every American".
Krugman's got you covered. And, his arch-conservative economist counterpart Greg Mankiw agrees with him.
posted by Citrus at 8:15 AM on September 26, 2008
Krugman's got you covered. And, his arch-conservative economist counterpart Greg Mankiw agrees with him.
posted by Citrus at 8:15 AM on September 26, 2008
but aren't there models that can account for such effects? Meteorology has feedback loops, but that doesn't make it impossible to predict the weather.
What the bundles are worth depends on whether we enter a recession. Whether we enter a recession depends on what the bundles are worth, AND ALSO a bunch of other stuff.
"Other stuff" includes obvious things like trillion-dollar bail-outs and banks collapsing; and more nebulous things like "investor confidence" and investor behaviour. In other words, the value of these mortgages depends on things which are hard to predict.
posted by Mike1024 at 9:00 AM on September 26, 2008
What the bundles are worth depends on whether we enter a recession. Whether we enter a recession depends on what the bundles are worth, AND ALSO a bunch of other stuff.
"Other stuff" includes obvious things like trillion-dollar bail-outs and banks collapsing; and more nebulous things like "investor confidence" and investor behaviour. In other words, the value of these mortgages depends on things which are hard to predict.
posted by Mike1024 at 9:00 AM on September 26, 2008
(I'm really no expert in any of this.)
Plus this other wrinkle - the "what is it worth if I sold it now" versus "what will it eventually be worth" question. (I've been seeing this referred to as the "fire sale price" versus the "hold to maturity" price.) So the $0 answer to "what is it worth" comes from the current market-based valuation: no one in the private market is currently willing to buy these things, thus they are currently worth $0.
Modeling based on assumptions about the performance of the underlying mortgages is looking towards hold to maturity valuation. But it's the current valuation that affects the financial stability of the institutions holding these things.
The bailout plan involves the government saying that as a player outside the market who believes that these securities will eventually be worth something and also has a separate motivation of rescuing the system, they are going to step in and declare a value by fiat by actually buying these things. What price they pick and where that lands against the ultimate value will determine just how much taxpayers lose or make on the deal. But the price they pick also has an impact in how well the "rescuing the system" part works - if it's not high enough, it doesn't help the current owners of the securities enough, and they fail anyway. So you want to go high enough to actually help, and low enough to not lose too much money. (And the more you help, the higher the price can be without losing money, since the mortgages will ultimately perform better if you've helped the economy more.)
That's the idea, I think.
posted by yarrow at 9:05 AM on September 26, 2008
Plus this other wrinkle - the "what is it worth if I sold it now" versus "what will it eventually be worth" question. (I've been seeing this referred to as the "fire sale price" versus the "hold to maturity" price.) So the $0 answer to "what is it worth" comes from the current market-based valuation: no one in the private market is currently willing to buy these things, thus they are currently worth $0.
Modeling based on assumptions about the performance of the underlying mortgages is looking towards hold to maturity valuation. But it's the current valuation that affects the financial stability of the institutions holding these things.
The bailout plan involves the government saying that as a player outside the market who believes that these securities will eventually be worth something and also has a separate motivation of rescuing the system, they are going to step in and declare a value by fiat by actually buying these things. What price they pick and where that lands against the ultimate value will determine just how much taxpayers lose or make on the deal. But the price they pick also has an impact in how well the "rescuing the system" part works - if it's not high enough, it doesn't help the current owners of the securities enough, and they fail anyway. So you want to go high enough to actually help, and low enough to not lose too much money. (And the more you help, the higher the price can be without losing money, since the mortgages will ultimately perform better if you've helped the economy more.)
That's the idea, I think.
posted by yarrow at 9:05 AM on September 26, 2008
Thanks, Mike1024 & yarrow, that helps.
posted by DevilsAdvocate at 10:12 AM on September 26, 2008
posted by DevilsAdvocate at 10:12 AM on September 26, 2008
Damn, schroedinger, your summation was incredibly well done. Kudos!
posted by EmpressCallipygos at 10:23 AM on September 26, 2008
posted by EmpressCallipygos at 10:23 AM on September 26, 2008
Can't anyone even say, "we estimate the value of this to be between $55 million and $70 million?" Seems like all anyone is saying is "it could be anywhere from $0 to $100 million."
The trouble is that they've been inventing very complicated variations on mortgage-backed securities, and those are even harder to value. For instance, you may have a tranche that really is worth $0 if 40% of the mortgages default, and worth the full value if 30% default. Plus, you know people were lying on those mortgage applications (or someone was lying for them), so the statistics you "know" aren't even necessarily valid. Tis a mess.
posted by smackfu at 11:38 AM on September 26, 2008
The trouble is that they've been inventing very complicated variations on mortgage-backed securities, and those are even harder to value. For instance, you may have a tranche that really is worth $0 if 40% of the mortgages default, and worth the full value if 30% default. Plus, you know people were lying on those mortgage applications (or someone was lying for them), so the statistics you "know" aren't even necessarily valid. Tis a mess.
posted by smackfu at 11:38 AM on September 26, 2008
The money is to be used to purchase large amounts of bank assets whose value is uncertain or worthless.
In order to lend out money a bank must have assets on their balance sheet. For every dollar in assets they are allowed to lend out $X, usually $10 or so. The idea is that in case some of those loans go belly-up, depositors at the bank need to know there are some reserves to draw on, a margin of safety in case a depositor wants to withdraw their money from a bank that has made bad loans.
To put assets on the balance sheet the assets have to have a value. The value is either known (an identical asset sold for $50 yesterday, so this asset is worth $50) or estimated.
Banks around the world are now holding hundreds of billions of dollars worth of assets whose value is unknown because a) the markets in those assets are frozen, i.e. *no* identical assets have traded on the market for several months and b) the models by which the asset prices are estimated are completely crapped out because no one can estimate the real amount of different risks that are going around.
For instance, AIG was insuring many trillions of dollars worth of mortgages against default. That means that if a mortgage defaulted, a bank got a payment from AIG. That affected the value of that mortgage, making it more valuable than if no insurance existed.
Unfortunately, the model of that asset's value may not have taken into account the idea that AIG could literally go out of business one day and not be able to pay out on any insurance claims. This idea is called 'counterparty risk.' Suddenly the value of that mortgage (or that mortgage backed security, or that credit derivative swap) is not what it was a day ago because it is no longer insured against loss, even though the money paid for that insurance is gone.
If you haven't noticed, a lot of firms (IndyMac, Lehman, WaMu, AIG) have ceased operations in the last week and their obligations will not be fulfilled. These firms were all heavily into providing this type of insurance. The 'counterparty risk' associated with their failures has paralyzed the markets because no one knows what these assets are worth now and no one is willing to risk overpaying for an asset that may be worthless in fact.
As we discussed above, banks are allowed to lend out more money than the assets they actually own, and they have to retract those loans if depositors get spooked and run the banks, withdrawing their assets. This crisis of confidence causes banks to fail. The worst case scenario is that every American individual and corporation finds themselves in this situation: the bank account statement says $X is in the bank, the American goes to the bank, the American finds that no money is available to withdraw. FDIC exists to protect against isolated bank failures but it can't protect against this.
Solution: offer a 'buyer of last resort' to purchase those assets of questionable value and get them off the bank's balance sheets so banks can feel confident to resume normal operations. The time for worrying about moral hazard is past; the fat cats have taken the money and run. It is now time to worry about the fact that all banks are about to become insolvent.
posted by ikkyu2 at 12:50 PM on September 26, 2008
In order to lend out money a bank must have assets on their balance sheet. For every dollar in assets they are allowed to lend out $X, usually $10 or so. The idea is that in case some of those loans go belly-up, depositors at the bank need to know there are some reserves to draw on, a margin of safety in case a depositor wants to withdraw their money from a bank that has made bad loans.
To put assets on the balance sheet the assets have to have a value. The value is either known (an identical asset sold for $50 yesterday, so this asset is worth $50) or estimated.
Banks around the world are now holding hundreds of billions of dollars worth of assets whose value is unknown because a) the markets in those assets are frozen, i.e. *no* identical assets have traded on the market for several months and b) the models by which the asset prices are estimated are completely crapped out because no one can estimate the real amount of different risks that are going around.
For instance, AIG was insuring many trillions of dollars worth of mortgages against default. That means that if a mortgage defaulted, a bank got a payment from AIG. That affected the value of that mortgage, making it more valuable than if no insurance existed.
Unfortunately, the model of that asset's value may not have taken into account the idea that AIG could literally go out of business one day and not be able to pay out on any insurance claims. This idea is called 'counterparty risk.' Suddenly the value of that mortgage (or that mortgage backed security, or that credit derivative swap) is not what it was a day ago because it is no longer insured against loss, even though the money paid for that insurance is gone.
If you haven't noticed, a lot of firms (IndyMac, Lehman, WaMu, AIG) have ceased operations in the last week and their obligations will not be fulfilled. These firms were all heavily into providing this type of insurance. The 'counterparty risk' associated with their failures has paralyzed the markets because no one knows what these assets are worth now and no one is willing to risk overpaying for an asset that may be worthless in fact.
As we discussed above, banks are allowed to lend out more money than the assets they actually own, and they have to retract those loans if depositors get spooked and run the banks, withdrawing their assets. This crisis of confidence causes banks to fail. The worst case scenario is that every American individual and corporation finds themselves in this situation: the bank account statement says $X is in the bank, the American goes to the bank, the American finds that no money is available to withdraw. FDIC exists to protect against isolated bank failures but it can't protect against this.
Solution: offer a 'buyer of last resort' to purchase those assets of questionable value and get them off the bank's balance sheets so banks can feel confident to resume normal operations. The time for worrying about moral hazard is past; the fat cats have taken the money and run. It is now time to worry about the fact that all banks are about to become insolvent.
posted by ikkyu2 at 12:50 PM on September 26, 2008
A Great Depression on steroids.
We do have at least one advantage over the Great Depression, though, and that's the FDIC insurance, which ensures that we will maintain at least some personal wealth.
The scary thing, to me, isn't that we'll go into a depression now, but that no one knows what the consequences will be 10-30 years from now.
posted by Airhen at 1:32 PM on September 26, 2008
We do have at least one advantage over the Great Depression, though, and that's the FDIC insurance, which ensures that we will maintain at least some personal wealth.
The scary thing, to me, isn't that we'll go into a depression now, but that no one knows what the consequences will be 10-30 years from now.
posted by Airhen at 1:32 PM on September 26, 2008
the FDIC insurance, which ensures that we will maintain at least some personal wealth
Are you aware that a $309 billion bank failed this week? FDIC insurance trust fund was $45 billion at the beginning of the year, and that was before the $32 billion IndyMac failure.
posted by ikkyu2 at 7:07 PM on September 26, 2008
Are you aware that a $309 billion bank failed this week? FDIC insurance trust fund was $45 billion at the beginning of the year, and that was before the $32 billion IndyMac failure.
posted by ikkyu2 at 7:07 PM on September 26, 2008
This thread is closed to new comments.
posted by iamkimiam at 6:08 AM on September 26, 2008