Tuesday, September 30, 2008

The Bailout: Myths, Half-Truths, and Inconsistencies

The mother of the mother of all bailouts is quickly turning into not just one of the largest financial events in history, but a heated political argument as well. As we head into a vote on Capitol Hill this week, many, many questions still remain unanswered about how this plan is structured and whether it should be implemented at all.

You're bound to get a different viewpoint from almost anyone you ask, but here are a few thoughts on four of the chief areas of debate getting tossed around.

Myth: The proposed bailout will cost taxpayers at least $700 billion
The proposed $700 billion isn't a donation, a grant, or a gift -- it's an investment. The money will be used to purchase assets from banks at a steep discount to nominal value, and then sold down the road once the smoke clears. The proceeds from those sales will ... say it with me ... go back to the Treasury and pay off the debt issued for the bailout. It's completely reasonable to assume taxpayers could in fact profit from this venture in years to come if done properly.

Half-truth: This is a bailout of Wall Street
Oh boy, I can already hear the keyboards furiously punching out the hate mail on this one, but, please, hear me out. This is not a bailout of Wall Street: It's a bailout of the American financial system from a problem caused by Wall Street (as well as Main Street). There's a tremendous difference between the two.

Inconsistency: The economy won't implode if a big bank goes under
After all, we hear that, "Lehman Brothers was allowed to go bankrupt and the world didn't come to an end." I can see why this is a widely held belief, but let's dig a little further into the events of two weeks ago. Lehman Brothers went belly up sometime Sunday afternoon. By Sunday evening, Merrill Lynch (NYSE: MER) had to be hastily thrown into Bank of America's (NYSE: BAC) arms. By Tuesday, AIG had imploded. By Thursday, Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) were on the brink of collapse.

I'll go out on a limb and assume that four once-in-a-lifetime events happening within 96 hours of each other wasn't a coincidence. The only thing that stopped the domino-style financial meltdown was word that the mother of all bailouts was taking shape. Like it or not, many of these firms truly are too big to fail.

Inconsistency: Let 'em fail, the sooner they die, the sooner we recover
Hogwash. "Tough medicine" makes sense insofar as the medicine isn't so tough that it kills you. The big factor that needs to be addressed here is that foreigners own more than one-quarter of all the public debt in America, which in effect gives them the ability to send the financial system into Armageddon if they sense our financial fortitude teeters on collapse.

Any large-scale fallout in the financial sector could give foreigners a good reason to start dumping treasuries en masse, causing a bank run on the largest debtor in the world: the U.S. government. There is no doubt that such a run would push the value of the dollar to unimaginable lows, as well as cause a domestic credit crisis to boil into a currency meltdown. Such a meltdown would make any recovery several orders of magnitude more difficult than it would be with the bailout.

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[9/25/08] Confident but not yet celebrating, congressional leaders agreed Thursday on a multibillion-dollar bailout plan for Wall Street aimed at staving off a national economic catastrophe. President Bush brought the two men fighting to succeed him to a historic White House huddle on how to sell a deal to lawmakers who were still resisting.

Under the tentative plan, the government would buy the toxic, mortgage-based assets of shaky financial institutions in a bid to keep them from going under and setting off a cascade of ruinous events, including wiped-out retirement savings, rising home foreclosures, closed businesses, and lost jobs. Bush warned darkly in a prime-time address Wednesday night, "Our entire economy is in danger."

While lawmakers engaged in nitty-gritty dealmaking, Democrat Barack Obama and Republican John McCain, who have each sought in their own ways to distance themselves from the unpopular Bush, prepared to sit down together with the sitting president at the White House for an hourlong afternoon session apparently without precedent. By also including Congress' Democratic and Republican leaders in the meeting, much of Washington's political power structure was to be gathered at one long table in a small West Wing room.

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