By Daniel Zarchy
Co-Editor in Chief
Welcome to Plan B.
With cries across the country for the government to fix the economy, Congress plans to implement their bailout plan by injecting $700 billion, or roughly 5 percent of the U.S. GDP, into the housing and credit market.
The controversial new plan involves routing it through the same Wall Street firms that prevailed over the credit market. Treasury Secretary Henry Paulson says this is the best way, but critics accuse the bailout of rewarding the very people who caused the problem.
The plan involves three stages of $250 billion, $100 billion and $300 billion, to be appropriated out to buy the almost worthless assets of companies at above market value, giving them cash to continue operating and to hopefully revitalize a failing market.
The hope is that rebooting the market will result in an accountable Wall Street with caps on executive compensation and stronger regulations for risky investment.
Still, to many, the question remains as to why we humble taxpayers should foot the bill for this massive safety net.
The answer? We have to.
Though the government does not make a habit of bailing out failing companies, the housing and mortgage industry remains one of the main drivers behind our economic strength. When it grows, we grow. When it fails, the world economy fails.
The main point of the bailout, as distilled from the speeches, articles and press releases on the issue, is to prevent a nationwide bank run, highlighting another odd sector of the world: the psychology of economics.
The worst thing that can happen to an economy is a drop in the confidence that people have in their banks. When times get bad enough, historically, people “run” to their banks, withdraw their life savings, and hide it under the mattress because it feels safer than leaving it in the bank. This happened during the Great Depression, and more recently during the Japanese banking crisis of the early ‘90s.
When people lose confidence, whether it’s people losing the confidence to put money in a bank or a bank losing confidence to give out loans, the economy stops moving. Businesses, which depend on loans to begin or expand, will stop hiring. People will stop working, and unemployment will spike.
In this realm, the $700 billion is only a small part of what the Federal Reserve and Treasury are doing to stem the drop in confidence.
Tuesday morning the Fed announced that it would guarantee short-term loans between businesses that many firms rely on to meet deadlines and pay their workers on time.
This is on top of an increase in deposit insurance from $100,000 to $250,000, or a guarantee that even if your bank fails, you’ll get up to a quarter million of your savings back. This is important because it will help people maintain trust in small and rural banks, which face the same confidence problems but are not big enough to warrant a government bailout.
The underlying problem here? Nobody knows what is going to happen. We are in uncharted territory, heads and tails above the bailouts of Chrysler or even Savings and Loan.
Also, though most in the economic disciplines push for some sort of bailout, there is still heated debate as to the form. Sweden experienced a similar financial crisis in 1992, and passed a bailout package equal to 4 percent of their GDP.
Their package had many similarities, except that instead of buying up the assets of a company, the government in essence nationalized the banking system, buying up huge piles of stock in failing companies instead of only their toxic assets.
This way, according to the then-Swedish finance minister in a New York Times article, it allowed the government to recoup its investment at the cost to shareholders, rather than taxpayers, while successfully bringing Sweden out of its economic crisis.
Still others have suggested using the money to bail out victimized borrowers, helping them to refinance their impossible mortgages and reach some level of sustainability.
Again, nobody can say which is better, because nobody can predict what will happen with one plan or another, or if we skipped the bailout altogether.
At this point economics is more an art than a science as predicting the outcome is near impossible.