Perhaps I can offer a different view on this.
The bailout purports to be helpful to borrowers, and this is true to some small degree. Helping people about to lose their homes is good political theater.
Actually, the problem lies in the derivatives market. To understand that issue better, let’s look at what happens with a mortgage.
An aspiring homeowner goes to a mortgage broker and applies. The mortgage is approved, and a fee is generated for the broker – which may be an individual, a bank, or a brokerage firm. The loan (mortgage) is then packaged with other loans and sold to investors. So far, so good, right? The purchasers of the package of loans have a responsibility to know the characteristics of the security they’re buying.
However, it’s possible to take a package of loans and put them together in a different way – for example, a CDO (Collateralized Debt Obligation). A CDO is broken into parts called “tranches”, which have different priorities for being repaid. Therefore, the highest quality tranch is paid before anyone else; however, they get a lower yield. Lower quality tranches get more yield, but accept more risk of not getting paid. The quality (or rating) is assigned according to a mathematical model created by the company selling the securities. Rating firms do not independently evaluate the model.
This gets far nastier. CDOs can be repackaged into new CDO securities (called CDO squared), and the new CDOs have tranches that, in turn, have different priorities for repayment. There are, as I understand it, CDO3 (CDO cubed) and CDO4 securities.
The problem? No one – not the Fed, not treasury, not the banks, not anyone – knows how to evaluate the securities. If someone wishes to sell them (or, for that matter, buy them), how does one come up with an appropriate price? It’s as if I strolled up and said I had a coin for sale, but couldn’t (or wouldn’t) provide other details. It might be a pure gold coin, of recognized type – or it might be a shiny penny. Unless you knew what you were buying, how could you possibly make a bid? So, to be safe, you’d offer a very low price. However, that means that the seller would take a horrific loss – and if the seller happened to be managing money for others, those clients (investors, whatever) would be quite unhappy. Lawsuits would be the order of the day.
Oh, but it gets worse. The derivatives are leveraged – a lot. So a small loss on the underlying security can completely wipe out capital. This happened to a hedge fund managed by a major Wall Street firm. By the way – state pension funds, banks around the world, and lots of other financial entities bought these things (CDOs and their cousins, CLOs).
We were, in fact, looking at a general failure of the global financial system. We probably aren’t out of the woods yet. I have been betting on inflation for some time, and it is developing apace. This is bad for the country – and devastating for the folks trying to live on a fixed income or a meager wage. If you think ammo is expensive, wait a year.
And if you want to look at the problematic aspect, ask what our national creditors will do as we debase the currency. Will they continue to hold trillions in U.S. debt securities, or will they sell? Will they continue to buy U.S. debt securities? Because if they sell (or even quit buying) long-term U.S. rates will go up a lot, no matter what the Fed does. If that occurs, times are likely to get hard.
Now….should the federal government bail out all these people? Probably not. Will there be a price to pay? Sure – massive inflation. Probably a weaker economy. But the consequences of not acting aren’t pretty either. So will politicians choose to defer the day of reckoning, even at the risk of making it worse? I’ll leave that answer to others.
Here’s a link for your reading “pleasure”.
LINK