I’ve been hesitant to offer my opinion about the proposed $700B bailout package since the news pertaining to that plan is ongoing and constantly changing. But now that rumors are flying and I’ve had clients call in to ‘blame this on Bush’ and to complain that it dumps a massive debt directly on the heads of taxpayers, I feel the need to spell out some truth as I understand it and perhaps some more realistic scenarios. Regardless of what portion of this proposed legislation passes, I don’t think we’re heading into the next Great Depression. The biggest problems with this market the way I understand it is a lack of liquidity, the perils of bank interdependency, and a need for some new regulations in an era of leverage and risk. These are problems we can cope with as a nation with a little cooperation. Here is some clarification about this historical event:
If the Fed does get approved to buy ‘bad debt’ off the balance sheets of various financial institutions it would mostly consist of them buying residential and commercial paper at a steep discount to its market value. Now, determining a market value for a pool of borrowed money which includes subprime issues and other alt-a paper is very difficult–often impossible in the midst of this ‘dead credit’ market which we’re currently in. In all likelihood, the government will buy these loans for 30 or 40 cents on the dollar, in some cases less. These purchases would be at ‘fire sale’ prices which, in a stable market, would be worth considerably more. While holding these loans, the government would be receiving the interest on these loan pools, in many cases ranging from 8-12% or more. If the Fed were to hold these loans to maturity, they could very possibly earn a profit because of the low purchase prices. Remember, most of these loans will not default after all. On the other hand, they can go ahead and sell that paper for 60 or 70 cents on the dollar, or perhaps more, representing what could be a massive profit. So, an important understanding would be that the government plans to re-sell these loans through competitive market mechanisms. $700B in taxpayer dollars would not be spent and gone–rather one could go as far as to say it represents a possible good investment of tax dollars. In the meanwhile, it will stabilize the markets, helping ordinary people, myself included, who hold money in 401k, 403b, IRA, and individual investment accounts. I’m sure most of us wouldn’t mind seeing our investment accounts bounce back towards their highs at some point in the not-so-distant future.
As for the recession, depression, inflation, and dollar concerns, we must return to the fact that we aren’t simply buying these debts off corporate balance sheets and taking them as a taxpayer loss. This will be a managed program aimed at stabilizing the market–not to give rich CEOs more room to breathe easy. Ben Bernanke went as far today as to say it’s as likely the Fed would lower interest rates in the future as it is they raise them. They don’t anticipate inflationary results from this legislation. The market tends to learn from its mistakes, and we’ve seen what happened to inflation and the dollar after the savings and loan crisis of the 1980s. This is a different time and a different problem. And I think once the dust settles Congress will realize the necessity for these measures along with their possible positive outcomes and sign off on it.
Russell Bailyn
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Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net
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