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Bailout Plan Talks Collapse Overnight as Congress Rebels

Politics / Credit Crisis Bailouts Sep 25, 2008 - 11:51 PM GMT

By: Nadeem_Walayat

Politics Best Financial Markets Analysis ArticleHank Paulson, the ex-CEO of Goldman Sachs investment bank, eager to bailout his Wall Street buddies to the tune of an initial down payment of $700 billion as well as protecting his own estimated portfolio of $600 million aided by his good buddy at the US Fed Ben Bernanke has hit a major hitch as bailout talks disintegrate late Thursday.

George Bush played his role on Wednesday by reading the dire end of the world script handed to him by President Paulson, so as to frighten the US electorate and their representatives into complying with Paulson's requests. The scene was set for a relative easy ride until talks began to disintegrate as President Bush admitted in his own unscripted words “If money isn't loosened up, this sucker could go down,”.

end of the world script

Whilst the dynamics of the breakdown are not clear in these early hours, as splits on both sides emerged as the Democrats increasingly saw the Bush Bailout plan more of a Bailout of McCain's election chances that lacked any form of stick to beat those on Wall Street that were responsible for the creation of the financial crisis. Meanwhile rebellious republicans wept for the demise of the Free Market mechanisms and suggested an alternative more voter friendly plan of rescuing home owners.

It is clear that the rail roading of the US Congress into signing a whopping initial $700 billion blank check by means of "shock and awe tactics" is starting to crumble as Congress respond the widespread disgust and anger, not only amongst ordinary Americans but much of the financial industry and market participants who have witnessed corner stones of the free markets being stripped away month on month and lately day by day as the worlds Government react to what can only be considered as fraud on a colossal scale that inflated the value of collatorised debt packages so as to allow huge annual bonuses to be banked even up to the end of 2007. Whilst these false accounting and valuation practices resulted in what were seen as safe solid banks holding huge exposure to over inflated assets that have been gradually marked lower over the last 12 months towards there true value.

However given the liberal use of leverage of in many cases in excess of X30 the banks assets have left most of the big banks more or less bankrupt, which now that much of the capital has been destroyed seek capital injection from the state in the form of unlimited bailout cash in exchange for the illiquid overvalued debt packages.

Whilst during the next 24 hours the debate in Washington will be centred around the detail of the financial bailout plan, which will eventually pass as the consequences of doing nothing would imply a total loss of confidence in credit. You may wondering what does that mean "total loss of confidence in credit" ?

As an example of the the way a "loss of confidence in credit" could manifest itself in every day life could be if retailers start charging a penalty for transactions involving credit cards of perhaps as much as 10% against cash transactions. Or refusing to take credit cards at all due to the risk of default on the transaction.

Another manifestation could be withdrawal of savings in excess of the insured limits which are then kept as cash under the mattress, perhaps later we will witness a surge in the purchase of home safes as currency is increasingly converted into say gold as a concentrated store of long-term value.

Whilst we are still some way, away from a collapse of confidence in fiat currencies such as the US Dollar, British Pound, and the Euro, we are however leaping along the path towards the day when people start to lose confidence in the paper currencies as realisation takes place that the real rates of inflation are far above the government manipulated statistics such as the CPI.

Despite all of the noise of Congress's qualms that we will witness played out during the next 24 hours or so, the bailout plan will more or less pass. Despite the fact that it represents madness, an ultimate manifestation of the subprime contaigent spreading and infecting the US Treasury with all of the consequences of loss of confidence in ALL US paper as the value of US debt devalues in the eyes of all investors.

Instead the real question that the peoples representatives should be focusing themselves on is how do we bring those who benefited from the greatest fraud in history to account for their actions and the possible repatriation of wealth stolen in recent years to the tune of more than $1 trillion due to huge bonuses paid on the back of boosted fake asset valuations. That would probably increase confidence in US paper than signing a blank check.

Meanwhile the US election of 2008 experiences its own credit freeze as John McCain finds a convenient excuse to avoid being humiliated at Fridays Foreign Policy debate by Barrack Obama, who now faces a dilemma of having to adopt to a slowdown in the pace of the election which gives his opponent time to recover from near knockout political blows in the lead up to an inevitable November election defeat for McCain.

Stock markets are expected to take a hit on Friday on the news, I would not be surprised if we witness another 500 point drop on the Dow Jones by the close. But the truth of the matter is that stocks will eventually settle where the value is that takes into account the negative consequences of the bailout therefore this implies any rally should be temporary in the light of the overall negative impact of the financial crisis and loss of confidence in US paper which is what the Bailout plan heralds.

More recent analysis on the credit crisis:

By Nadeem Walayat

Copyright © 2005-08 (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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© 2005-2022 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


26 Sep 08, 16:07
Don't Bail Them Out

It's interesting, isn't it, that all these people believe that waving the magic money wand can make reality just go away.

This fellow writes much better than I.

Read this article for an accurate and educational look it the world.

26 Sep 08, 16:08
Don't Bail Them Out

My side protected the banking system-- and will protect the United States from the error of inaction in the face of the need to keep open for business and keep eating every day.

Old man-- to young to know which way is up-- try fasting for the time it takes nations to recover from disasters that meet with inaction. (I'll be 83 in 18 days-- just how old are you -- and when did you lose your mind?)

26 Sep 08, 16:08

The poorest of folks are hurt the very worst by the inflation caused by the fedres' policy of expanding the money supply. This bailout will be a huge boost to inflation in a few years.

Inflation hurts those on a fixed income. Governemnt check recievers get a regular cost of living increase. It is so rude and false when social security recipents claim to be on a fixed income.

26 Sep 08, 16:09
End of Capitalism

It is unfortunate that in capitalist society the government has to intervene on the management of private companies, moreover in the decision making of investment houses and giant mortgage companies. Anyone who is having economic difficulties at this point is thinking that "bailing out" large private equity firms is not the way to go, unfortunately ............. is it the way to go. As a consumer i am looking at the situation with point of deception and disbelief; but as a well informed individual investor i have to say that the way our economy works is complex and no matter how many people claim to know it the reality is that it is very hard to understand; especially if you look at the fact that this is all in our heads, and by that i mean that what is driving this companies down the proverbial toilet is the lack of consumer and investor confidence.... Also you have to acknowledge the part the media play in this whole situation. The general public need not be alarmed when a bear market is on its way because that only drops consumer confidence and eventually makes companies lose some of their value sheet. Personally, I think that the idea of non-educated consumers trying to discuss complex economic derivatives and exotic financial instruments i.e "naked put", "short sales", "warrants" and what not... only increases the idea that gossiping is good for us while in reality it only deprives us from really learning how processes work. Moving on to the "bail out plan", we have to understand that this is not a bailing out of Wall Street, this is just a loan which will potentially be used to buy "illiquid assets" being held by large financial firms such as Fannie Mae, Freddi Mac, etc. and what that would do is allow this companies to go back into the process of lending and easing credit to the individual and commercial consumers, that way our economy does not go into official recession... What most average Americans do not realize at this point is the fact that this is an investment and chances are it will be successful, it wont take a couple of weeks;... in fact it make take some 5 or even 10 years for thing to go back to normal; but the American economy is resilient and it will recover after all remember that we have had many bear markets and as many cyclical process the economy jumps back up to show us a bull market... so in conclusion the;;; this is an investment that will pay over time and it is very likely that the taxpayer will end up benefiting from it rather that footing the bill.

American Patriot
26 Sep 08, 16:12
President Bush's Speech on Financial Crisis

BUSH: Good evening. This is an extraordinary period for America's economy.

Over the past few weeks, many Americans have felt anxiety about their finances and their future. I understand their worry and their frustration.

We've seen triple-digit swings in the stock market. Major financial institutions have teetered on the edge of collapse, and some have failed. As uncertainty has grown, many banks have restricted lending, credit markets have frozen, and families and businesses have found it harder to borrow money.

We're in the midst of a serious financial crisis, and the federal government is responding with decisive action.

We boosted confidence in money market mutual funds and acted to prevent major investors from intentionally driving down stocks for their own personal gain.

Most importantly, my administration is working with Congress to address the root cause behind much of the instability in our markets.

Financial assets related to home mortgages have lost value during the house decline, and the banks holding these assets have restricted credit. As a result, our entire economy is in danger.

So I propose that the federal government reduce the risk posed by these troubled assets and supply urgently needed money so banks and other financial institutions can avoid collapse and resume lending.

This rescue effort is not aimed at preserving any individual company or industry. It is aimed at preserving America's overall economy.

It will help American consumers and businesses get credit to meet their daily needs and create jobs. And it will help send a signal to markets around the world that America's financial system is back on track.

I know many Americans have questions tonight: How did we reach this point in our economy? How will the solution I propose work? And what does this mean for your financial future?

These are good questions, and they deserve clear answers.

First, how did our economy reach this point? Well, most economists agree that the problems we're witnessing today developed over a long period of time. For more than a decade, a massive amount of money flowed into the United States from investors abroad because our country is an attractive and secure place to do business.

This large influx of money to U.S. banks and financial institutions, along with low interest rates, made it easier for Americans to get credit. These developments allowed more families to borrow money for cars, and homes, and college tuition, some for the first time. They allowed more entrepreneurs to get loans to start new businesses and create jobs.

Unfortunately, there were also some serious negative consequences, particularly in the housing market. Easy credit, combined with the faulty assumption that home values would continue to rise, led to excesses and bad decisions.

Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay. Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on.

Optimism about housing values also led to a boom in home construction. Eventually, the number of new houses exceeded the number of people willing to buy them. And with supply exceeding demand, housing prices fell, and this created a problem.

Borrowers with adjustable-rate mortgages, who had been planning to sell or refinance their homes at a higher price, were stuck with homes worth less than expected, along with mortgage payments they could not afford.

As a result, many mortgage-holders began to default. These widespread defaults had effects far beyond the housing market.

See, in today's mortgage industry, home loans are often packaged together and converted into financial products called mortgage-backed securities. These securities were sold to investors around the world.

Many investors assumed these securities were trustworthy and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac.

Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.

The decline in the housing market set off a domino effect across our economy. When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses.

Before long, these securities became so unreliable that they were not being bought or sold. Investment banks, such as Bear Stearns and Lehman Brothers, found themselves saddled with large amounts of assets they could not sell. They ran out of money needed to meet their immediate obligations, and they faced imminent collapse.

Other banks found themselves in severe financial trouble. These banks began holding on to their money, and lending dried up, and the gears of the American financial system began grinding to a halt.

With the situation becoming more precarious by the day, I faced a choice, to step in with dramatic government action or to stand back and allow the irresponsible actions of some to undermine the financial security of all.

I'm a strong believer in free enterprise, so my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business.

Under normal circumstances, I would have followed this course. But these are not normal circumstances. The market is not functioning properly. There has been a widespread loss of confidence, and major sectors of America's financial system are at risk of shutting down.

The government's top economic experts warn that, without immediate action by Congress, America could slip into a financial panic and a distressing scenario would unfold.

More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically.

And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs.

Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And, ultimately, our country could experience a long and painful recession.

Fellow citizens, we must not let this happen. I appreciate the work of leaders from both parties in both houses of Congress to address this problem and to make improvements to the proposal my administration sent to them.

There is a spirit of cooperation between Democrats and Republicans and between Congress and this administration. In that spirit, I've invited Senators McCain and Obama to join congressional leaders of both parties at the White House tomorrow to help speed our discussions toward a bipartisan bill.

I know that an economic rescue package will present a tough vote for many members of Congress. It is difficult to pass a bill that commits so much of the taxpayers' hard-earned money.

I also understand the frustration of responsible Americans who pay their mortgages on time, file their tax returns every April 15th, and are reluctant to pay the cost of excesses on Wall Street.

But given the situation we are facing, not passing a bill now would cost these Americans much more later.

Many Americans are asking, how would a rescue plan work? After much discussion, there's now widespread agreement on the principles such a plan would include.

It would remove the risk posed by the troubled assets, including mortgage-backed securities, now clogging the financial system. This would free banks to resume the flow of credit to American families and businesses.

Any rescue plan should also be designed to ensure that taxpayers are protected. It should welcome the participation of financial institutions, large and small. It should make certain that failed executives do not receive a windfall from your tax dollars.

It should establish a bipartisan board to oversee the plan's implementation, and it should be enacted as soon as possible.

In close consultation with Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, and SEC Chairman Chris Cox, I announced a plan on Friday.

First, the plan is big enough to solve a serious problem. Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system.

In the short term, this will free up banks to resume the flow of credit to American families and businesses, and this will help our economy grow.

Second, as markets have lost confidence in mortgage-backed securities, their prices have dropped sharply, yet the value of many of these assets will likely be higher than their current price, because the vast majority of Americans will ultimately pay off their mortgages.

The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal.

And when that happens, money will flow back to the Treasury as these assets are sold, and we expect that much, if not all, of the tax dollars we invest will be paid back.

The final question is, what does this mean for your economic future? Well, the primary steps — purpose of the steps I've outlined tonight is to safeguard the financial security of American workers, and families, and small businesses. The federal government also continues to enforce laws and regulations protecting your money.

The Treasury Department recently offered government insurance for money market mutual funds. And through the FDIC, every savings account, checking account, and certificate of deposit is insured by the federal government for up to $100,000.

The FDIC has been in existence for 75 years, and no one has ever lost a penny on an insured deposit, and this will not change.

Once this crisis is resolved, there will be time to update our financial regulatory structures. Our 21st-century global economy remains regulated largely by outdated 20th-century laws.

Recently, we've seen how one company can grow so large that its failure jeopardizes the entire financial system.

Earlier this year, Secretary Paulson proposed a blueprint that would modernize our financial regulations. For example, the Federal Reserve would be authorized to take a closer look at the operations of companies across the financial spectrum and ensure that their practices do not threaten overall financial stability.

There are other good ideas, and members of Congress should consider them. As they do, they must ensure that efforts to regulate Wall Street do not end up hampering our economy's ability to grow.

In the long run, Americans have good reason to be confident in our economic strength. Despite corrections in the marketplace and instances of abuse, democratic capitalism is the best system ever devised.

It has unleashed the talents and the productivity and entrepreneurial spirit of our citizens. It has made this country the best place in the world to invest and do business. And it gives our economy the flexibility and resilience to absorb shocks, adjust, and bounce back.

Our economy is facing a moment of great challenge, but we've overcome tough challenges before, and we will overcome this one.

I know that Americans sometimes get discouraged by the tone in Washington and the seemingly endless partisan struggles, yet history has shown that, in times of real trial, elected officials rise to the occasion.

And together we will show the world once again what kind of country America is: a nation that tackles problems head on, where leaders come together to meet great tests, and where people of every background can work hard, develop their talents, and realize their dreams.

Thank you for listening. May God bless you.

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