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Who Are We Bailing Out? And Why?

It is questionable whether the congressional bailout deal will do any good whatsoever.

by
Jeffrey Carter

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September 28, 2008 - 1:18 am
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When the framers of the Constitution thought about the future for American capitalism, they certainly didn’t think the government would be taking this giant leap that last night’s financial bailout represents.

We know it will cost us money, no matter what the politicians promise. As anyone in finance knows, dollars today are worth a lot more than tomorrow’s dollars, so the upfront cost should be kept as small as possible.

The question in the public’s mind is this: Exactly who are we bailing out?  Why?

The why part is easier to answer.  The CDO that is talked about is like you selling your car to Joe, but not getting any money today for it.  Joe is going to pay you next year.  As soon as Joe gets your car, he rents it to Jim.  Jim doesn’t pay him, but offers to pay him monthly for the use of the car.  Jim sells the car to a chop shop.  The chop shop pays Jim a commission, and sells pieces of the car at a profit to Tim, Tom, Dick, and Harry.  Harry buys Dick’s pieces, and puts together a new car — but has an accident.  How is Joe going to collect?  Who really owns the car?  Of course it’s more complicated than that, but you get the idea.  The government is going to bail out everyone, or pick a person in the chain.

The real issue the government should focus on is the credit market, not the stock market.  The interbank market where banks and very large entities borrow and trade with one another is broken.  Banks no longer trust the collateral that is being posted to trade with.  Accounting standards are fuzzy, so they don’t know how to value collateral.  Without the interbank market, the stock market fizzles.  Eventually, it means that John and Jane Doe on the street cannot get credit that they desire to start or expand a business, or buy or fix up a home. The government in the past year since the credit crunch manifested itself, has put a band-aid on a problem that needs a tourniquet.

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