Commentary: Bankruptcy, not bailout, is the right answer

[CompoundInterestFan]

Commentary: Bankruptcy, not bailout, is the right answer - CNN.com

This is why I'm still on the fence about the bailout. I'm not an economist, and I keep hearing reassurances from both sides that their way is the right way. Can someone explain the flaws in this article? In other words, why will the world end if the bailout isn't passed?

[freebird5825]

this paragraph from the article says it all for me...

"The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer."

i'm trying to get my brain to absorb all of the discussions in the news. maybe i'm oversimplifying it, but the phrase "survival of the fittest" comes to mind regarding the fate of financial institutions that screwed up.

[riskadverse]

Bernanke is for it.
Paulson is for it.
Bush is for it.
My Senators are for it.
My congressman is for it.
CNBC is for it.
Wall Street is for it.


Bend over and take your medicine.

[ls99]

Quote:

Originally Posted by riskadverse Bernanke is for it. Paulson is for it. Bush is for it. My Senators are for it. My congressman is for it. CNBC is for it. Wall Street is for it. Bend over and take your medicine.

No thanks!

All the more reason for them to $hove it. No need for the taxpayer to buy the bad loans.

Those that could or would not read the terms of their mortgage should loose their houses.

[Notmuchlonger]

Quote:

Originally Posted by riskadverse Bernanke is for it. Paulson is for it. Bush is for it. My Senators are for it. My congressman is for it. CNBC is for it. Wall Street is for it. Bend over and take your medicine.

Right everyone we elected as a people is for it. It either works or we suffer more pain and point fingers at each other

[Hobo]

Here's the logic that I can accept... we know floating around out there in the ether are a bunch of crazy financial instruments which have one thing in common... they all have real estate (ie, houses) as their security. The problem is no one can draw a straight line from one financial instrument to one particular house. No. Maybe a thousand financial instruments have a hundred different houses as collateral.

To make matters worse, no one knows the true value of the houses, AND no one knows the if the homeowner can afford to make the mortgage payments.

If you are a bank or other financial company, and you own some of these financial instruments, there is no way to know how much they are worth. Have they lost 25% of their value because of the housing bubble that burst? 50% or more? Banks have a piece of paper that does have value - no question if you untangle the ball of twine, you will find underlying value.

But banks and investors get real nervous when the cannot put an exact price on that piece of paper. No one wants to buy the paper, no wants to lend on the paper for a very good reason - no one knows how much it is worth. And so the banks are headed into bankruptcy. Bad things happen when banks go into bankruptcy - consumers cannot get a loan, business cannot get a loan, and the company that you work for cannot get a loan - which may mean you loose your job, no to mention your 401k.

So the government buys the whole lot of all these screwy financial instruments which have real estate as an underlying security at a substantial discount. Now the banks have money again and can go about their business as usual.

Meanwhile the government owns a ton of real estate and nobody knows exactly how much it is worth. But in a few years, all of this is going to sort itself out as houses are sold - either voluntarily or by foreclosure. Ever time a house is sold, the ball of twine gets less complex - and at the same time, the money from the sale of the house goes back to new owner... the US government.

Eventually, the banks will be back in business - but probably still stinging from the loss it took by seeing financial securities to the government - but still in business.

Meanwhile the government/tax payer is slowly getting repaid for the original "bailout" every time another house is sold. In time, the government quite possibly could make money from the sale of all this real estate that it bought at a discount way back in 2008.

It all kind of reminds me of the game of Monopoly where the strategy is to buy up all the real estate and hope the roll of the dice don't go against you. If you loose the game, well, you still have a nice country to live in - I guess you can consider it the price of rent to live in the USA.

[Texas Proud]

Quote:

Originally Posted by Hobo Here's the logic that I can accept... we know floating around out there in the ether are a bunch of crazy financial instruments which have one thing in common... they all have real estate (ie, houses) as their security. The problem is no one can draw a straight line from one financial instrument to one particular house. No. Maybe a thousand financial instruments have a hundred different houses as collateral. To make matters worse, no one knows the true value of the houses, AND no one knows the if the homeowner can afford to make the mortgage payments.....

Not quite true... it is VERY easy to find out which trust owns the mortgage of the house... and who is servicing that mortgage...

The HARD part is finding out who is due the cash flow of that mortgage... if you bought the interest part of that mortgage... you do NOT want it to pay off or refinance or anything... just amortize over the life of the loan... If you bought the principal part, you want it refinanced as soon as possible...

And that does not take into account that the principal might have many people who have a claim... say, if it is only a 10% decline it all goes to A, but B is whole...


But, what the price of the securities are saying is that... well, most of the money is already gone... it was due to lending 100% of the value of a house... and now that house is down 40% or more... and we still have to foreclose and sell... and even more of a discount... this is a time when EVERYBODY is doing the same thing...

I would say paying 30% for them does not give enough 'reward' for the risk you are taking... yes, some of them are worth 50% or even 60%... are you sure you can pick correctly?

[Martha]

This issue isn't whether people should bear the consequences of their bad decisions, the issue is whether the effect on the economy is so large that we all suffer serious consequences, for example, lack of credit for good businesses and good business ideas and increased unemployment which will create its own fallout.

However, I do tend to think that a modification of the bankruptcy code would be good systematic way to allow people to restructure home debt for less than the amount owed. People then suffer the consequences of bankuptcy but are still given the chance to work things out based on a court approved budget. Currently, you can't rewrite your home debt to its value in bankruptcy.

[MasterBlaster]

Quote:

Originally Posted by Martha This issue isn't whether people should bear the consequences of their bad decisions, the issue is whether the effect on the economy is so large that we all suffer serious consequences, for example, lack of credit for good businesses and good business ideas and increased unemployment which will create its own fallout.

I couldn't help but notice that about $ 1.4 Trillion was lost in the equity markets on Monday (and that's just in the US). How low do we have to go ? How many businesses need to go under ? And how many people need to lose their livelihood before we (collectively) think that their problem is our problem ?

So we can either teach Wall Street a lesson here and feel smug, or we can do what is in our own best interest. One or the other but not both.

[FinanceDude]

Quote:

Originally Posted by MasterBlaster I couldn't help but notice that about $ 1.4 Trillion was lost in the equity markets on Monday (and that's just in the US). How low do we have to go ? How many businesses need to go under ? And how many people need to lose their livelihood before we (collectively) think that their problem is our problem ? So we can either teach Wall Street a lesson here and feel smug, or we can do what is in our own best interest. One or the other but not both.

How much was REGAINED in the equity markets yesterday? probably about a trillion........

[MasterBlaster]

Quote:

Originally Posted by FinanceDude How much was REGAINED in the equity markets yesterday? probably about a trillion........

That is true it came back somewhat. However watch what happens if the Senate votes no tonight.

My point wasn't so much the blow-by blow market beat. It was that so much more is at stake than the proposed amount of the mortgage bailout.

[harley]

Quote:

Originally Posted by MasterBlaster I couldn't help but notice that about $ 1.4 Trillion was lost in the equity markets on Monday (and that's just in the US). How low do we have to go ? How many businesses need to go under ? And how many people need to lose their livelihood before we (collectively) think that their problem is our problem ? So we can either teach Wall Street a lesson here and feel smug, or we can do what is in our own best interest. One or the other but not both.

I keep hearing this opinion, and every time it causes me to remember a quote from Ben Franklin. I usually use it in regards to the Patriot Act and other post 9/11 activities, but it seems to apply here too - "They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety."

I'm not trying to be a hardass, and I believe in charity and helping your neighbor. However, just like I have to do with my daughter, keeping people from feeling the consequences of their actions also keeps them from learning not to repeat them. There's plenty of blame to go around, and we all need to feel it, learn from it, and DON'T DO IT AGAIN.!

I just can't justify having my daughter and granddaughter pay for their entire lives for the actions of the gov't and social and financial systems we allowed to happen.

[barbarus]

Quote:

Originally Posted by Martha This issue isn't whether people should bear the consequences of their bad decisions, the issue is whether the effect on the economy is so large that we all suffer serious consequences, for example, lack of credit for good businesses and good business ideas and increased unemployment which will create its own fallout. However, I do tend to think that a modification of the bankruptcy code would be good systematic way to allow people to restructure home debt for less than the amount owed. People then suffer the consequences of bankuptcy but are still given the chance to work things out based on a court approved budget. Currently, you can't rewrite your home debt to its value in bankruptcy.

This will not change the fact that many bought far more house than they could afford, even at 0% interest for the rest of their lives. Solving the credit-crunch would help the economy certainly, but the housing scam was simply too big and widespread.

Terrible pain now or disaster later.

No real bailout will work for long. The scam was just far too ubiquitous.

No bailout. It won't work.

[ls99]

While I agree that one issue is the economy at large. A good massive failure would awaken the voters to see the bad effects of socialistic regulations having forced many banks to issue mortgages to marginally (at best) qualified borrowers. Then at the upcoming elections get rid of all the politicians who advocated passing of socialistic regulations.

Then start paying attention to what politicians are doing.

The other option is bow to the socialists and change the form of government to either true democracy or socialism instead of the Republic which we are.

[haha]

Quote:

Originally Posted by ls99 While I agree that one issue is the economy at large. A good massive failure would awaken the voters to see the bad effects of socialistic regulations having forced many banks to issue mortgages to marginally (at best) qualified borrowers. Then at the upcoming elections get rid of all the politicians who advocated passing of socialistic regulations.

This is not how it would work. Any radical knows that anything they can do to make things worse actually advances their agenda. A good massive failure" would bring on a more authoritarian and abusive New Deal than the old New Deal was.

Ha

[Kwirk]

Quote:

Originally Posted by ls99 socialistic regulations having forced many banks to issue mortgages to marginally (at best) qualified borrowers

Can you clarify this? Which regulations?

[ls99]

Quote:

Originally Posted by Kwirk Can you clarify this? Which regulations?

Community reinvestment rules.

[FinanceDude]

I am still wondering WHY we need a BAILOUT to keep the credit markets functioning. It's almost like the banks are REFUSING to take on NEW GOOD DEBTS, just because they were stupid and made some large BAD DEBTS. THEY can control their own underwriting, so they can only make loans to folks that, well, DESERVE THEM!!!

[. . . Yrs to Go]

Quote:

Originally Posted by CompoundInterestFan Commentary: Bankruptcy, not bailout, is the right answer - CNN.com This is why I'm still on the fence about the bailout. I'm not an economist, and I keep hearing reassurances from both sides that their way is the right way. Can someone explain the flaws in this article? In other words, why will the world end if the bailout isn't passed?

So much misinformation, so little time.

First the premise that this was caused, and can be fixed, by dealing with Fannie & Freddie and the Community Reinvestment Act is hogwash. Fannie & Freddie didn't originate subprime loans. In fact, the vast majority of their portfolio was "conforming loans" (non-jumbo, full documentation, standard 20% down payment, etc. etc.). They were allowed to grow too big because of their "implicit guarantee", but that is an entirely different matter.

Also the idea that lenders ran headlong and recklessly into subprime and securitization because the Government told them to is flat out silly. They went overboard because boatloads of money was to be made (or so they thought) and would have done so even if the Feds never uttered a peep.

As to bankruptcy. I think its a good and necessary option in most cases. The problem is, we've let too many institutions become "too big" (or more accurately "too interconnected") to fail. The government tried to let Lehman go and the result was potential cascading failures (AIG the biggest among them).

The problem was/is, "bad" financial institutions were/are threatening "good" financial institutions. Both Goldman Sachs and Morgan Stanley have been profitable throughout this whole mess but I'm convinced they would have filed for bankruptcy last week had the government not floated the "bailout" idea. How many other institution, both "good" and "bad" would Goldman and Morgan have taken down?

We can either try to adress this situation one institution at a time as they fail, which is what we have been doing (Fannie & Freddie ($200B), Bear Stearns ($32B), AIG ($85B), Wachovia ($??), Countrywide, WaMu, Lehman, . . .). Or we can try to address the problem in a systematic way, which is what the "bailout" hopes to do. The "bailout" is not the only way to tackle this problem systematically. But simply saying "let them file for bankruptcy" is a recipe for a complete collapse of our financial system, and, our economy and standard of living with it.

[Independent]

Quote:

Originally Posted by . . . Yrs to Go The problem was/is, "bad" financial institutions were/are threatening "good" financial institutions. Both Goldman Sachs and Morgan Stanley have been profitable throughout this whole mess but I'm convinced they would have filed for bankruptcy last week had the government not floated the "bailout" idea. How many other institution, both "good" and "bad" would Goldman and Morgan have taken down?

This is the important part of the article to me:

Quote:

Thoughtful advocates of the bailout might concede this perspective [that the bailout creates a moral hazard], but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time. Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen. Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

I think both sides agree that the bailout trades short term gains against long term losses. The short term gain is that we keep more people working with the bailout. The long term loss is that we reinforce the idea that if you are big enough you can make risky bets and privatize the profits and socialize the losses.

The question for me is "How many average people lose their jobs, and for how long?" When people talk about "complete meltdown", I don't know what they mean. We certainly aren't going to go to 100% unemployment.

What does "complete meltdown" mean? 10% unemployment? I've lived through that, and most economists would say it was a necessary evil that allowed us to break the stagflation of the 70's.

Maybe a severe recession is the cost of chasing excess leverage, and the notion that the gov't will always step in and save your hide, out of the system. If it really worked out that way, I might be willing to make the trade.