Financial turmoil
Calloway School's Bliss explains what you need to know about the $700 billion bailout plan
Professor Rob Bliss, who holds the F.M. Kirby Chair in Business Excellence in the Wayne Calloway School of Business and Accountancy, discusses the $700 billion financial industry rescue bill and what the financial crisis means to the average person. Bliss is an expert on banking, financial market regulation and insolvency resolution and a former senior financial economist at the Federal Reserve Bank of Chicago.
What is the bailout plan meant to accomplish?
The purpose of the bailout is to authorize the government to buy mortgage-related securities from banks. By making these purchases, the government will establish a value on these securities and replace the mortgages sitting on balance sheets with cash so banks can resume lending. In normal market conditions, banks would sell these mortgages themselves, but with today's credit market crisis, they can't because there's no market.
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How did they arrive at the $700 billion figure?
Seven hundred billion dollars is 5% of the outstanding mortgages. An auction mechanism will be used to determine the value of the mortgages and to avoid paying too much for them.
How does this affect the taxpayer?
The government will borrow money to get the cash for the bailout so our national debt will go up by $700 billion. The Treasury will use the money to buy the mortgages and then hold them until markets are back to normal or until they mature.
If the Treasury holds the mortgages until they can sell them for a profit, the taxpayer will come out ahead, right?
The Treasury may make a profit or take a loss. If the Treasury makes a profit, the taxpayers will benefit. But, taxpayers can lose in two ways — if the Treasury pays too much for the mortgages or if the Treasury, once they own the mortgages, writes down their values.
Why would the Treasury write down the values?
Once the government has the mortgages, there will be political pressure to allow people to keep their houses. Let's say a borrower has a mortgage for $120,000 and the house is worth $90,000. The government then writes down the mortgage, essentially lowering the amount owed on the house from $120,000 to $90,000. Now, this may make sense if the person really cannot pay, because the cost of foreclosing is high. The danger is that people will realize the government is a soft touch and those who can pay back their mortgages will say they can't. Losses from these write downs will be at the taxpayers expense.
If write-downs are an option, why didn't the banks do this?
The government has funded a $300 billion program to encourage banks to do this. However the program has been little used both because the structure of the program makes it unattractive to banks and because many borrowers cannot afford to pay even if the mortgage is written down.
Is limiting executive compensation a good idea?
This is a gesture made for political reasons. It won't help banks and may discourage participation. Remember "bail out" means "help." The goal is to save banks not punish them. Anyway, the language in the bill regarding compensation limits is pretty weak.
Why didn't the bill pass the U.S. House?
Politics.
There seems to be growing public opposition to the plan?
Most people don't understand the seriousness of this crisis. It's complicated and seems remote, a Wall Street problem. And there is a huge confidence problem. People don't trust the institutions of government or the Federal Reserve. We need leadership and we don't have it. If we wait until the voters "feel the pain," their pain will be much greater and protracted.
The public was first told that a bill had to be passed immediately or the economy would grind to a halt. Yet almost a week has gone by without action. Does the chance of the bill's passage decrease as time goes by?
There are two components to the crisis: the real component and the psychological component. The bill sought to address both by responding quickly with a bold program. Unfortunately, the moment for addressing the psychological aspect of the crisis may have slipped away. Meanwhile the crisis has spread beyond the mortgage market that this proposal targets.
Without a bailout, how long do you anticipate it might take the economy to recover?
Even with a bailout, financial difficulties will almost certainly roll into next year. The new President and Congress will then take actions that will either help or hurt the situation. The chance of a severe recession, however, is getting bigger because action is being delayed.
Are there any other options other than approving the bailout legislation?
I suppose, if there is no bailout, the Congress could quietly pass an increase in the debt ceiling to allow the Treasury to borrow more money and continue various lending programs. We're running out of options.
How does regulation versus deregulation fit into the bailout debate?
The crisis has revealed some very serious problems in the regulation of our financial markets. When Washington Mutual failed the bank closed quickly and all was done in 24 hours, and that's what you want to happen. Failures should be resolved quickly. When Bear Stearns failed earlier in the year regulators did not have the power to close and seize it the way they did with Washington Mutual. Instead they had to arrange a convoluted deal with JP Morgan that was anything but clean. They had to push the envelope on their legal powers. It would have been good for the regulators to have the same powers for investment banks as for commercial banks. We need to take a long hard look at regulations both nationally and internationally, but this should not be attempted now during a crisis and during an election but after a resolution is in place.
Why can't we continue to wait and let market forces play out? Market forces are causing the markets to lock up. Companies can't wait months to borrow money. As a result they will begin to cut back on hiring. On a personal level, if someone needs to move to a new city for a job, they need to be able to sell their house. They can't wait many months for the buyer to find a mortgage.
Wouldn't it be a good thing if this discouraged people from borrowing too much?
We're now paying for the party we enjoyed when easy credit and rising housing prices led to spending beyond our means as a nation. Some other countries have experienced similar bubbles: the UK currently and Japan in the 1990s. We will get back to a time of more rational financial behavior, but between now and then it's going to be painful — especially for financial institutions.
If I'm a homeowner with an affordable mortgage, a car that's paid off and no credit card debt, why should I worry?
You're in a very good position — even if you have debt — if you can pay it off every month and if your job is secure. You don't, however, want to rely on credit cards to get you through the month without some backup funds. For many people, their financial world is moving as usual. I go to the ATM and withdraw cash. I still use my credit card. But the fact that I don't notice any change in my financial activities doesn't mean that there isn't a crisis or that I'm not going to feel its impact.
If I'm a student and the bailout bill doesn't pass, will it be harder to get a loan next year. Will my rate go up?
It will be harder to get loans for school and rates will likely go up. But scarcity rather than rates is the more pressing issue. There will be more stringent conditions on loans.
Do I need to worry about my cash?
Banks are safe. The FDIC insures accounts up to $100,000. If you have money in a money market account, check to see that the mutual fund participates in the government insurance program. The government recently announced an unlimited insurance program for money market accounts but the mutual fund must pay a fee to participate, so be sure yours is insured. Spread your money around, and make sure you're liquid.
Is there anything hopeful about the situation?
We're seeing weak players taken over and the hope is that the big banks left standing will be strong ones.
What are the best resources for learning more about the financial crisis and the bailout plan?
When I want to find out about a specific episode, I go to the Treasury Web site
or the Federal Reserve Web site to read the actual press releases rather than turning to the newspapers for interpretations. The press reflects the discussions taking place in the political realm and these are often short on facts and tend to be emotional.
