Why we Need the Bailout

First I want to recognize Chris for all of the research he put into this post, thank you. I also want to thank LaterSkater for your forwards and and a preemptive thank you for helping me not to assault the English language with my grammar.

I think there are a lot of questions out there centering on why we need a bailout and ‘why can’t we let the market sort all of these things out’? I realize this is an extreme analogy, but that would be similar to letting cancer work itself out. The prime requirement for a capitalist society isn’t having access to every market, low taxes or little regulation. The most important thing in a capitalist society are functioning capital markets and that is what the crisis we are currently facing is about.

There are several reasons why we are currently in this financial crisis and I try to address some of them in an earlier post. The point is we will have plenty of time to assign blame and credit later but for now we need to act. In the future I will make a post detailing how Marx predicted wild market swings would be the impetus to societies becoming communist, something we all want to avoid. Swings like this have largely been avoided throughout our history due to a tradition of government intervention dating back to Alexander Hamilton. The belief that the proposed intervention is an affront to American ideals and traditions is not supported by our history.

Why We Need IT

The reason we need the bailout is because credit markets have “locked up”. What does that mean….

• Nobody wants to loan anybody any money (1)
• Businesses need overnight money to make payroll (short term credit/ lines of credit) and they are having trouble getting them now (1)
• The failure of Lehman has caused banks to be reluctant to lend money to each other (4)
• The $586 Billion in credit losses has banks scrambling to restore their capital (4)
• If banks are unwilling to lend to each other — as surging LIBOR rates suggest — they sure aren’t going to lend to consumers or businesses (7)

Without access to credit business will not be able to make payrolls, fund needed projects, purchase raw materials for manufacturing cover their cash flow while they wait for projects to close, etc. Even if companies are able to get access to credit at higher premiums they will need to cut costs just to maintain their performance. This generally manifests itself in the form of massive layoffs, which in turn hurts the economy since the unemployed tend to spend less. Most companies are leveraged (as they should be) and have some level of revolving debt. If this debt is coming due and they need to issue new debt their operating costs just went up. This again leads to less investment and more layoffs.

I think there is a misconception that this crisis is primarily about helping the financial sector, which it is also intended to do. However every capital intensive organization is being affected by this, especially manufacturing, information technology and municipal / state governments. The credit crisis is coming up on a year old, lets look at some specific example of how it is affecting the economy:

- http://www.capitalspectator.com/092508b.html

http://seekingalpha.com/article/97377-the-perfect-storm-even-with-bailout-economy-is-hurting

• Because of this tightness in the market for tax-free municipal bonds, Kent County, Mich., where Grand Rapids is located, will pay some $750,000 more than it expected in interest on a $15 million, 10-year refinancing bond it sent to market earlier this week, according to county treasurer Kenneth D. Parrish.(11)
• Matt Fabian, managing director of the research firm Municipal Market Advisors, said the problems extend throughout the municipal bond market, where the borrowing rate for seven-day debt spiked from 1.8 percent to 5.15 percent last week. (11)
• Louisiana added $14.3 billion to its budget for fiscal 2007 to account for higher borrowing costs (11)
• For the week through September 20, fresh claims for unemployment benefits jumped sharply to 493,000, the Labor Department reports. (12) The last time initial claims were reaching so close to the 500,000 mark was September 2001. (13)
• Seasonally adjusted new orders for durable goods slumped 4.5% in August, the biggest percentage drop since January.(14)
• Home prices fell about 6% in 2007 and are expected to tumble another 15% in 2008, 10% in 2009 and 5% in 2010 (15)
• The credit markets are seizing up and the uncertainty recently drove up short-term interest rates for municipalities and some rock-solid institutions such as New York’s Metropolitan Museum of Art to 20%.(15)
• Compared to a year ago Caterpillar will pay about $15.6 million more per year to borrow the same amount (17)
• Compared to just six weeks ago Caterpillar is going to be paying an additional 150 basis points for a similar debt instrument(16)
• Caterpillar actually got a great deal because the average premium that A-rated corporate borrowers have been required to pony up has jumped 331 basis points from last year (17)
• Jumbo Mortgages (loans above $420k) now carry an extra 1.2% interest (18)
• Credit card offers are down 17% from the same time last year (18)
• American Express is cutting the credit limit of 10% of their customers (18)
• Since the summer of 2007, 137 lenders have stopped funding federal loans (18)
• Thirty three lenders have suspended private student loan programs (18)
• Student loans made to parents through the Parent PLUS program have plummeted — down 29% in dollar volume year (18)
• Bank of America is declining to increase lending to McDonald’s franchisees even though the two companies have a long-standing partnership (18)
• In August, 67% of small-business owners said they’d been affected by the credit crunch (18)

Who Ultimately is Being Affected

• Investors or anyone who has a 401(k), etc/ Obvious reasons (10)
• Students looking for student loans and parents looking to get them loans(10)
• Anybody with Credit Card debit / Most CC rates are based on LIBOR plus a figure. LIBOR has been soaring (10) (18)
• Anybody looking to buy a car / People are having challenges getting financed unless you have impeccable credit. (10)(18)
• People looking to buy a house (10)(18)
• Anybody looking to start a business
• Anybody running a business who needs money to cover payroll until money comes in
• People with ARMs that will be adjusting / They are often based on LIBOR which is soaring
• Homeowners / additional foreclosures will drive down their home values
• Taxpayers / Higher borrowing costs for local and state government will result in a need to either cut services or raise taxes

Even with the bailout the economy is going to get worse before it gets better. The damage that has been done is probably going to take a couple years to finish working it’s way out.  The next shoe to drop is going to be large dip in consumer spending which should push the economy further down in a recession.  The question do we want to face both problems at once.

I live for comments, feedback and forum posts so please let me know you thoughts on this post. If you think this is a worthwhile post don’t forget to add it your social networking site listed when you click the ‘bookmark’ button.

Thanks,
-ep

Sources
1. The Markets Are Terrified: Should You Be?- http://finance.yahoo.com/tech-ticker/article/79549/The-Markets-Are-Terrified-Should-You-Be?tickers=%5EDJI,%5EGSPC,%5EIXIC,SPY,DIA
2. The Dow’s Worst Days: http://www.forbes.com/2007/02/28/dow-jones-worst-days-biz-cx_daa_0228dow_slide_3.html?thisSpeed=15000
3. Who Really Benefits from the Bailout – Wall Street or Main Street: http://finance.yahoo.com/tech-ticker/article/77810/Who-Really-Benefits-from-the-Bailout—-Wall-Street-or-Main-Street?tickers=%5Edji,%5Egspc,%5Eixic,itw,ir
4. Fed Pumps Further $630 Billion into financial system: http://www.bloomberg.com/apps/news?pid=20601087&sid=a9MTZEgukPLY&refer=home
5. Treasuries Soar as House Rejects $700 Billion bailout http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aDMAlgibsQDw
6. Run on Bank Helped Kill WaMu, But Your Money Is Safe - http://finance.yahoo.com/tech-ticker/article/73415/Run-on-Bank-Helped-Kill-WaMu-But-Your-Money-Is-Safe?tickers=WM,JPM,XLF,WB,%5EDJI,%5EGSPC
7. ‘This Sucker Could Go Down’: Bailout Stalls, Market on Edge - http://finance.yahoo.com/tech-ticker/article/73263/’This-Sucker-Could-Go-Down’-Bailout-Stalls-Market-on-Edge?tickers=RIMM,GE,GT,%5EDJI,%5EGSPC,%5EIXIC,XLF
8. Goodyear to Tap Credit Due to Money-Fund Woes http://online.wsj.com/article/SB122234656358675027.html
9. Citigroup to acquire Wachovia banking operations- http://www.reuters.com/article/marketsNews/idINN2946959920080929?rpc=44&pageNumber=2&virtualBrandChannel=0&sp=true
10. Who wins, who loses under proposed bailout plan?- http://biz.yahoo.com/ap/080929/rescue_winners_losers.html?.&.pf=banking-budgeting
11. Credit crunch makes cities’ borrowing more costly http://biz.yahoo.com/ap/080926/financial_meltdown_public_finance.html
12. US Dept. of Labor: http://www.dol.gov/opa/media/press/eta/ui/current.htm
13. The Perfect Storm: Even with Bailout, Economy Is Hurting- http://seekingalpha.com/article/97377-the-perfect-storm-even-with-bailout-economy-is-hurting
14. Advance Report on Durable Goods Manufacturers’ Shipments, Inventories and Orders/ August 2008- http://www.census.gov/indicator/www/m3/adv/pdf/durgd.pdf
15. How Bad Will the Mortgage Crisis Get?http://www.time.com/time/business/article/0,8599,1714725,00.html?iid=sphere-inline-bottom
16. Caterpillar’s Troubling Bond Issue- http://seekingalpha.com/article/96992-caterpillar-s-troubling-bond-issue
17. Caterpillar bond sale illustrates credit crunch- http://money.aol.ca/article/caterpillar-bond-sale-illustrates-credit-crunch/357594/
18. The Credit Crunch: Where Is It Happening? http://www.time.com/time/business/article/0,8599,1845818,00.html?cnn=yes

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