The politics of reviving the bailout deal

Get Shorty

Problem is that the bail-out bill is flawed and the banks will still be under-capitalised. Credit will continue to shrink with business and consumer defaults rocketing. All the defaults are only for sub-prime so far in this cycle.
It is very likely we will have a severe recession lasting at least two years.

Ian C

The cause of the crisis over the Paulson measures was massive failure of political leadership – i.e. Bush. He should have known, but no one is surprised to learn that he did not, that the Paulson Plan would be interpreted in the country as a whole as a bailout of the main offenders – the bankers. At the same time as introducing the plan there should have been a package for distressed borrowers. Politically, one without the other, 6 weeks before an election was like lobbing a hand grenade into crowded room.

That neither of the Presidential candidates saw this, either, is also incredible. Think of the opportunity missed by them both. If either had identified that this was the case they would be out of sight in the polls by the end of this week. Ironically, now it is the Democrats who are supporting an unpopular bailout and the redundant last act of the Bush administration.

So if the final measure is materially altered before going through, and it needs to be as there are some major items missing and flaws that are now highly visible thanks to the delays and the debate that has gone on, it could be that it’s the Democrats who suffer in the Congress elections. But McCain will be hammered now that he did not spot the opportunity presented to him.

The politicians, as well as the financial markets, all panicked.

Augustus

In reality, the main question must be: How long can the US Federal Reserve keep bailing out Wall Street? It may sound unbelievable, but the total liabilities being taken on by the Fed and the US Treasury are now so big that the Government itself could default. The banks rescue package could even open up a can of worms as other distressed US industries, such as automotives, seek a similar rescue?

The Fed has already nearly run out of money. It has currently only a limited number of T-bills left to sell. That means that the US Treasury has to sell more bonds to foreign investors to raise more money to fund the central bank. But will his Chinese friends be happy to pick up the bill for Hank Paulson?

This bailout will swell the national debt to record levels, and really into unchartered waters. With nobody trusting the value of the dodgy assets (from mortgage debt to CDOs) being sold on the money markets, banks are allowed to borrow from the Fed by pledging these dodgy assets as collateral. And now with the aim of taking $700bn of the most unwanted subprime debts off Wall Street's balance sheet, not to mention the $200bn bailout of Fannie and Freddie and the $85bn the Fed gave to AIG, if the Government Plan doesn't work, the future for American taxpayers will look very black indeed.

The economist Hyman Minsky said in 1982 that the most significant economic event since the Second World War "is something that hasn't happened:
There hasn't been a deep and long-lasting depression". That could be about to change.

Ian C

Augustus

The main question is one of getting the financial system moving so that more bailouts, and T-Bills, are not needed.

The Paulson plan was politically naiive for what it left out and its "trust me I'm an Investment Banker" approach. It needs to be held back by too much short term oversight like an ash tray on a bicycle. Making Paulson dance for the next tranche is tantamount to cutting the package by 2/3rds.

The $700bn is only c.5% of GDP and easily financeable IF it can be got on with. Whether it would be deployed the best way bu this plan is however, open to question.