toxic assets<\/em>.<\/p>\n So now we’ve got banks and other big financial firms that are, effectively, bankrupt: they’ve god huge debts which they can’t pay back, because both the collateral for the loan,
\nand the stuff that the loan was used to buy are both now close to worthless.<\/p>\n
That’s the basic background.<\/p>\n
The Proposed Bailout<\/h3>\n
What’s the current proposed bailout? The idea is to prevent the banks from
\ngoing bankrupt by helping them sell those so-called toxic assets. If they can get enough
\nmoney by selling those, then they’ll be able to pay off their debts.<\/p>\n
Of course, if they could just make enough money by selling them to pay off their debts,
\nthey would have done that already. No one wants to buy that crap for full price. People will
\nbuy it for a fraction of its face value, but buying full price? That’s ridiculous: we
\nknow<\/em> that they’re based on bad loans, most of which will never be repaid.<\/p>\n So what the bailout tries to do is make the toxic assets into slightly more attractive
\ninvestments. And the way that they’re proposing to do that is by providing low-interest loans
\nto help people buy them, and by saying that if the things they bought using the loans lose
\nvalue, the loans will be forgiven.<\/p>\n
With that incentive, it becomes a much better risk. After all, for the guys buying it
\nusing the loans, most of the money that’s going to be risked buying the garbage isn’t theirs.
\nAnd the stuff is<\/em> bad – but it’s not all<\/em> worthless. Some portion of those
\nloans will get paid back. Some of those CDOs will eventually make some money. Most probably
\nwon’t. But some<\/em> will. And they’re not going to be selling for full price – they’ll
\nsell for a lot more than they’d get without<\/em> government help, but still less than
\nface value. So at the discounted price, a lot of them will make some<\/em> money.<\/p>\n What the government is proposing to do is to hand out loans to investors, which
\nthey can then use to buy up some of those bad assets. If the asset makes a profit, the
\ninvestor pays off the loan. If it doesn’t<\/em>, the loan is forgiven. Something like
\n85% of the purchase price of the toxic assets can be covered by one of these
\nno-recourse loans. So the investor is only on the hook for 15% if it doesn’t work out.<\/p>\n That leads us to part one of why people are upset: what this loan program basically does
\nis what Paul Krugman calls “privatizing the gains, socializing the losses.” Just think about
\nwhat happens to the money backing those loans. If the assets purchased using the loans make
\nmoney, then the private folks pay back the loan, and keep all of the profits. If the assets
\npurchased by those loans don’t make money, the loan is forgiven – and the loss falls onto the
\ntaxpayers. So the taxpayers whose money is backing this plan will get stuck covering the
\nfailures, but they get no share of the successes. In other words, one way of looking at it is
\nthat it’s a huge transfer of money from the federal treasury to wealthy investors. That’s all
\ntoo typical of how things have been working in our economy over the last couple of
\ndecades.<\/p>\n
But to make matters worse, there’s another reason to be upset: because there’s cause
\nto believe that the whole thing won’t work. Even though it will effectively transfer something like a trillion dollars from the government to private investors, it still won’t fix the basic problems with the banks or the economy!<\/p>\n
That argument is based on the fact that there are really two different ways that a
\nbank can fail. A bank can fail because of something called a run, and it can fail because
\nit’s really bankrupt. The proposed bailout will work if the basic problem is a run; but
\nit won’t work if it’s a bankruptcy. <\/p>\n
Banks operate by borrowing money from depositors. When you put money into your bank
\naccount, you’re actually loaning it<\/em> to the bank. As a payment for the loan, they pay you interest, or they provide you with some set of services. Then they take your money, and
\nthey invest it – either by giving loans, or by buying various kinds of assets. The difference
\nbetween what they make on their investments of the money that they borrowed from you, and
\nwhat they owe you in interest and services is their profit.<\/p>\n The catch to this is that the money that’s invested is not available for immediate return
\nto all of the depositors. Banks invest in a lot of long-term things that they can’t pull money
\nout of on a moments notice. So if everyone who deposited money in the bank suddenly wants
\nto pull their money out at the same time, despite the fact that the bank hasn’t lost anyone’s
\nmoney, they can’t pay back all of the depositors. That’s what a bank run is: when everyone
\nwants to pull money out at once, and the bank can’t do it because the money is tied up. The
\nthing about a run is that the bank does basically have the money – it’s just that they can’t
\nget it immediately. In a run, the government can help a bank in two ways: it can either loan
\nthem money to cover them until they can sell their investments, or it can buy the investments from them. In either case, what the government is doing is providing a short-term bridge. It works because the bank does<\/em> have the necessary assets; it just needs time to cash
\nthem in.<\/p>\n The other way that a bank can fail is bankruptcy. That is, it’s got a bunch of
\npeople that it borrowed money from to invest in some collection of assets. But the assets
\nlost value, and they’re worth less<\/em> that what the bank owes. It’s not a short term
\nproblem, where they just need help covering things until they can sell assets – they’re
\ngenuinely short of assets: they owe more money than they have in assets. In this case,
\nthe stopgaps don’t help – because all that they do is give the bank time to sell its
\nassets. If they’re really not worth as much as the bank owes, then time doesn’t help.<\/p>\n The current proposed bailout is designed assuming that the problem right now is just a
\nbank run. That is, the banks and financial firms really do have enough assets to cover
\neverything; it’s just that due to people’s paranoia, they can’t sell them right now. But given
\ntime, people will realize how much they’re actually worth – and when that happens, the banks
\nwill have plenty of money to pay off their debts. So all that the government needs to do to
\nsolve the problem is to provide a way for the banks to cash in those toxic assets for their
\nreal value, and everything will be OK.<\/p>\n
But what many critics believe is that the assets in question are genuinely worthless,
\nwhich means that the banks and financial firms are really bankrupt. The assets that they’re
\ntrying to get rid of aren’t worth anything. The problem is that they really don’t have
\nenough assets – they’ve got piles of paper, but that paper isn’t worth anything close
\nto what they owe, and it’s never going to be. They’re never going to be able to
\npay off those debts. Never.<\/p>\n
So helping the banks to sell worthless paper as if it was worth something isn’t really
\ndoing anything about the fundamental problem. All it’s really doing is handing the banks
\nmoney to cover part of their bad debts – but pretending<\/em> to be doing something
\nelse.<\/p>\n Worse, that way of handling the bad debt isn’t going to work. Because the total
\nsize of the bad debt dwarfs the amount of money that’s going to be used for buying those
\ntoxic assets. The total amount of money that these big firms have tied up in garbage isn’t
\nknow for certain, but I’ve seen estimates ranging from 3 trillion to 45 trillion
\ndollars! So at best<\/em>, this plan covers 1\/3 of the bank debts. That’s not enough to save them from bankruptcy. So this supposed rescue amounts to handing the banks a trillion
\ndollars, without actually solving the problem.<\/p>\n","protected":false},"excerpt":{"rendered":"It’s economics time again. I hate economics. I find it hopelessly dull. But apparently my style of explaining it is really helpful to people, so they keep sending me questions; and as usual, I do my best to try to answer them. Even if I don’t particularly enjoy it. So people have been asking me […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":false,"jetpack_social_options":{"image_generator_settings":{"template":"highway","default_image_id":0,"font":"","enabled":false},"version":2}},"categories":[71],"tags":[],"class_list":["post-758","post","type-post","status-publish","format-standard","hentry","category-bad-economics"],"jetpack_publicize_connections":[],"jetpack_featured_media_url":"","jetpack_shortlink":"https:\/\/wp.me\/p4lzZS-ce","jetpack_sharing_enabled":true,"jetpack_likes_enabled":true,"_links":{"self":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts\/758","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/comments?post=758"}],"version-history":[{"count":0,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts\/758\/revisions"}],"wp:attachment":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/media?parent=758"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/categories?post=758"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/tags?post=758"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}