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Commentary

Will the Bailout really change anything?

Thoughts:

  • Look at Calculated Risk’s “ForeClosure Alley” post. The video there is fascinating – of entire neighbourhoods hit hard with foreclosure. A comment from a person

    ” We paid 399 [thousand] for it. And the house down the street is gone for 180. Yeah. It makes me feel like I’ve made a stupid, stupid decision”…”I’m just losing everything. I could do a lot with my $3100 a month than to put into a place that’s not worth $1000.”

    The bill is not going to change any of this. When house prices are down, and going further down, there is no way a bailout of the banks is going to change the mindset that a homeowner has better uses for a monthly payment than to pay a house worth half of the price he bought it.

  • The bailout contains absolutely nothing that forces banks to continue to lend to the American economy. Let’s see now, who’s getting affected here? It’s the small farmer who needs a two month loan for harvesting equipment. It’s the marginal small business owner who needs a payroll loan to manage cash flow. It’s credit at the middle end – from the municipalities that need to build roads or set up lighting or whatever, to businesses that need to pay their vendors, to traders that need a line of credit for inventory, to individuals that need credit because the things one needs now aren’t cheap anymore.To cheer them up, you need credit flowing again. But right now there is a severe lack of trust – in the ability of the banks to lend to each other so that credit can trickle down. So then, we do things like suspend mark-to-market accounting for the time being, and purchase distressed assets. So how does this help credit flow back? There is no requirement for these banks to lend again.
  • Buying assets freezes the seller’s losses, so capital is depleted. Example: Let’s say a bank has $1000. It’s levered 10x so the bank’s lent out $10,000 in 10 loans worth, say, $1000 each. Let’s now say that five of these are “distressed” – at or near foreclosure. The treasury buys all 10, including the distressed 5, at a whopping 94 cents to a dollar.The bank now has to take the 6% loss, on the portfolio of $10,000. (And it has to give some capital to the treasury, but let’s leave that for now) That’s a $600 loss to capital. That means, of the original $1000, there’s only $400 left to lend. The bank still has 10x leverage, so it can do $4000. Which is four loans of $1000 each.

    From 10 loans down to 4 loans only. The bailout does nothing to help that. Unless these banks get more capital – they can’t lend further.

    The argument is that banks can’t find capital unless they sell these assets. And they are not willing to sell them at current prices (not that they can’t find buyers, they just refuse to sell at these prices). So if they sell to the treasury, they are going to take the money and do what? Find more capital? They will have to give it away for a song, and even then, lending will be ultra conservative, because new capital will demand that boss, I don’t want to see crap on your books.

  • I cannot understand how a crisis created by overleverage and oversupply of money can be solved by supplying even more money. We have got to face the recession that will come, regardless of what we do, because the only way to solve this is to cut leverage and cut money spends. It’s going to be bad, but a bailout will not change that. The cost of the recession is going to be a couple trillion dollars at least. And all the bailout does is adds $700 billion to that figure.

Eventually this is political game, not an economic one. I expect the bailout bill to be passed by the house on Friday. And in the next two quarters I expect gargantuan dilution by everyone involved. And it’s likely that we will start hearing how the bailout is not working, but then what else could one do. I wonder sometimes – isn’t it better to do nothing.

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