Why the "bailout" won't work.

Discussion in 'Economics' started by empee, Sep 28, 2008.

  1. empee


    The problem is not one of liquidity, its one of solvency. Put another way, the problem isn't that there isn't money to make loans (there is), the problem is the entities that need to borrow (such as banks) aren't solvent -- they don't have the ability to generate the income to pay the debt and interest.

    Remember there are 'assets' and a liability associated with this asset (when using borrowed money). The assets have dropped in value, say to 10% of the original value, but the debt has remained. How to service it?

    The next stage is probably some of suspension of mark-to-market rules. Why? Because even with the government willing to buy toxic assets, banks would be forced to mark what those assets sold for, not what they have on their books (if they marked what they were worth on their books, they would have to raise capital which they can't do). In essence, for the plan to work the banks needs to dump the toxic "assets" while maintaining their value on their balance sheet. Essentially, this is shifting the liability since someone at some point needs to make up this difference.

    There is no credit crunch. There was a credit ORGY. However, it ended. This is the aftermath; the whole system is built on lies and deceit. That banks won't lend to each other is a very rational response when everyone thinks the other is cooking its books and posting fake numbers. If you don't think the counterparty can pay you back, why would you lend?

    Imagine a guy with a credit card in over his head.. to the point he can't even pay the interest forget the principle. At some point in normal society the debt get liquidiated (seizing of assets, bankruptcy, whatever). and life goes on.

    Likewise, that is what has happened here. The exception is that instead of the guy going bankrupt, the debt has been shifted/become the liability of the whole neighborhood!

    Its not clear what we would buy these assets for. At one point, Bernanke said more than fair value (?) but not how much. So perhaps the government is saying we'll buy $1 bills for $10, but we'll be ok because the $1s are really $5s (??). Or perhaps its buying $10 bills for $1, because they are really worth $5. Who knows.

    Ultimately, for debt to be serviced it is claim on future earnings which are generated by labor.

    In a rational/fair society, we would destroy the debt since its unservicable (a business deal that went wrong), similar to a VC investing in a business that went bankrupt.

    Instead, we are going to maintain the debt and make a claim against the future labor of someone to service it. I wonder who that will be?

    Ultimately, we find ourselves on the road to indentured servitude -- a promise of freedom yet unable to ever pay off the debt + interest accumulated by our government. How much interest and debt is an average American, rather government mule willing to service?
  2. Thanks for this posting it is very clear.
  3. empee



    As noted, part of the bailout is suspension of mark-to-market. In addition, reserves are set to 0.

    The suspension of the mark-to-market will actually make lending tougher in my opinion because now you are institutionalizing lying about what your assets are worth. I.e. ok, govt inhales $700 billion in tox assets at whatever the price banks have on their sheets. This still leaves banks in the precarious situation of not being able to lend to each other since they still don't know who's solvent.

    Alternatively, the US inhales all the bad debt and leaves it to be worked off by the middle class.

    This policy makes no sense and is the worst of all worlds. Better would have been as suggested by economists to write down the value and have government recapitalize the banks; its basically what we're doing anyway except getting a worse deal for taxpayers.

    We need everyone to start functioning honestly so that banks can start lending to each other again (I believe each other to be solvent) and capable of repaying loans.

    Instead, we're doing everything possible to keep either monetizing the debt (through "temporary fed loans" that will last forever) and keep the game of musical chairs going.

  4. Exactamente empee ... a good post

    And here lies the core of the problem, the US economy is leveraged out beyond it's maximum servicing ratio......way way beyond in fact.

    And so, either the average household income needs an enormous boost or a rapid programme of de-leveraging needs to begin, coupled with interest cuts.

    First and foremost lies Nov 4 and the US tax payer needs to be distracted past this point.

    And then comes Christmas ......

    And then comes ...................??????
    I seriously doubt whether people will forget '09

  5. wave


    "Instead, we're doing everything possible to keep either monetizing the debt (through "temporary fed loans" that will last forever) and keep the game of musical chairs going."

    False economy, false lifestyles. The music stopped and now the DJ's are panicking. What they are proposing is akin to listening to the music 'skipping' like playing old vinyl LP's.
  6. Well boys, it looks like we lost this round.
  7. The losers are the 10s of millions of decent US earners and tax payers who are being burdened with the debt of the irresponsible lifestyles of others plus the ridiculous cost of military tourism.

    Now they are being faced with....

    ...higher taxes to come

    ... a big downturn in their earnings as internal consumption rolls over ( just wait until the Christmas figures are posted)

    ... and a big restriction in their freedoms

    this mess has been above the horizon for years.

  8. pismo10


    When has the govt ever jumped in and everything becomes alright? Never.
  9. Not a problem big enough the government can't make worse.
  10. bump!
    #10     Oct 3, 2008