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Bailout Bill…Round 2

The senate is putting together a new version of the bill that failed earlier this week.

Reports from Washington are that the senate has been feverishly re-tooling the bailout bill with adjustments that will make it more palatable for the public and more likely to pass through the House of Representatives.  Early reports are that an increase in FDIC insurance for bank deposits is being increased for the first time since 1980 from $100,000 per depositor to $250,000.  With the national average bank balance being around $5000, this will have little practical affect on consumers.  But, it can help small businesses feel more secure, and the overall perception is likely to show that there is more for the common tax payer than the original version.

It is not yet clear what other components have been added or removed, but there is no doubt that the pressure is on Washington to do something based on the reaction of the stock market this week.  Also, given an unprecidented amount of discontent towards any bailout plan (some reports say as many as 80% of tax payers are violently opposed to the bill), there is no doubt that those who vote for it should read it carefully as the outcome will likely dictate their fate in November.

I do find it interesting how much the public misunderstands the significance of passing legislation to help this problem.  I was listening to talk radio locally here in Pensacola yesterday, and the overall sentiment is still that there is no incentive to the tax payer and that this simply bails out millionaires that made bad decisions.  Unfortunately, the actual problem is much more detrimental to the overall economy than most people realize or even understand.  For instance, many small businesses rely on credit to run their daily operations.  For a car dealer, it is their line of credit that they use to purchase inventory to put on the lot.  For the plumber that wins a bid for a large job, they need access to credit lines to purchase inventory to be able to start the job.  Given that 80% of all americans work for a small business (defined by a company with 200 or less employees), the amount of layoffs and jobless claims as a result of the business being unable to grow could be more than we have ever seen in this country.

This problem began with the deregulation of mortgages through Congress during the Clinton administration in the late 90’s, and became a widespread problem as banks were forced to make loans to certain low income borrowers or face economic sanctions from the government.  It was understood that a percentage of these mortgages would fail at the time that they were originated, but that was understood as the cost of doing business on the part of lending institutions.  This is not when Subprime loans were born, but it certainly gave them the steroids to go into the wildly risky direction that they were 3 or 4 years ago.  I’m sure you won’t hear much in the news about this because no one in Washington would ever willfully take responsibility for something that had a negative affect on the economy.  In fact, most of our elected officials do not understand the financial markets enough to even know that they created the problem.  Now that the chickens have come home to roost, it is Congress that has to clean up its mess.

No one wants government intervention less than I do.  But, the cost of a lack of action is far greater than the cost of any bill that may be passed.

House Votes Down Bailout Bill

Much of the financial market expected the bailout bill to be passed, but the tides have changed.

After non-stop press coverage for almost 2 weeks, and a never ending jockeying for position in front of the camera by the talking heads in Washington, the wall street bailout bill has crashed and burned on the floor of the house of representatives.  With nearly a 2 to 1 vote against the bill by Republicans, and 94 Democrats voting against it, clearly the constituents negativity towards this has driven the House to vote down the bill.

Since most people on Main Street don’t understand the magnitude of the credit markets right now, perhaps they will get a better understanding after checking their portfolios at the end of trading today.  After expecting a bailout to be passed, the dow plunged down over 700 points after the vote went the wrong way.  Analysts are saying that without a bailout package from Washington, the Dow could drop as much as 2500 points before settling on a bottom, which will most certainly affect Main Street.  Even worse than the uncertainty in the stock market would be the affect that a freeze in credit would have on small businesses.

I think after seeing the aftermath, there will be another vote, and there will be some sort of bailout proposal passed.  The question remains, how long will that take?  And, have many casualties will be left on the battlefield before then?

What Does Wall Street Bailout Mean To Main Street?

With so many opinions about what is happening with the economy, what does this mean to you?

Wow, what a week.  There is no shortage of fireworks on Capitol Hill as the Senate Banking Committee continues to throw Fed Chairman Ben Bernanke and Secretary of Treasury Hank Paulson on the grenade.  The one constant that continues to be thrown around by members of the committee is that this unprecidented measure will “cost” tax payers $700 billion.  I am afraid that this term is being lost on the committee as it is also being lost by tax payers and citizens due largely to a misunderstanding of what this “bailout” actaully involves.

Let me qualify this by saying that I am a very large opponent of gevernment intervention at any level.  There is nothing that the government gets involved with that makes anything cheaper, more effective or more efficient.  That being said, we have reached a monumental point in the financial markets where intervention is necessary to avoid a total collapse of the financial markets that is nearly immeasurable by most people alive today.  Unless you are in your 80’s, it is unlikely you can truly appreciate what affect the depression had on this country (myself included).  The argument being made is that tax payers are being asked to foot the bill for mistakes made by people and organizations that they had nothing to do with, and to a limited extent that is true.

What is really going on is a total lack of faith in the system due to the unwillingness of financial institutions not only to lend money to consumers, but also to each other to keep the system fluid and capitalized.  When using the term bailout, you must see the bigger picture of what is actually going on.  The Fed and Treasury Department are proposing to the Senate Banking Committee that the government purchase certain mortgage backed securities from financial institutions that need help to liquidate these securities to continue in business.  If you own a pizza parlor, you can only remain in business if you sell pizzas for more than the cost to make them, use the proceeds to buy supplies, and repeat the process.  The same is true in the financial industry.  Banks can only lend money after taking certain securities, liqudating them in the open market, recovering the cash, and lending it again for a profit.  This is a highly simplified version of what is happening, but it has very complicated and wide reaching implications in all of our lives.

Some of these securities are owned by your pension fund, or your local municipality, or even your investment banker (as we have already seen with Bear Sterns and Lehman Brothers).  While it is pertrayed in the media and misunderstood by elected officials that this is a $700 billion line item expense to the tax payers, that in fact is not true.  It is actually the government purchasing assets with the intention of holding them and selling later.  The proposal is also suggesting that the securities be purchased in a reverse auction fashion where the banks most desperate will sell first at the lowest coupon rate, and as the value rises, the market will dictate what is reasonable to sell for each individual company.

In the end, the actual cost to the tax payer will be much less than $700 billion, in fact, it will more likely be a fraction of that.  The result of this action would be to open up a logjam in the system allowing institutions to become more liquid, be able to lend more money to consumers, and increase consumer confidence in the economy as a whole.

As you sit in Smallville, USA and wonder why you would go along with such a deal, be aware of the fact that farmers who need short term financing to get their crops to market are affected.  Car companies that employ thousands of people to build and sell cars are affected.  And, small businesses that need money to expand and grow and create more jobs are affected.  This may have originated on Wall Street, but there is a very real impact on Main Street that could create real problems if it is not done.