Rationale for the bailout
In his testimony before the U.S. Senate, Treasury Secretary Henry Paulson summarized the rationale for the bailout:Stabilize the economy:
"We must... avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy."Improve liquidity:
"These bad loans have created a chain reaction and last week our credit markets froze – even some Main Street non-financial companies had trouble financing their normal business operations. If that situation were to persist, it would threaten all parts of our economy."Comprehensive strategy:
"We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil. And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth."Immediate and significant:
"This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence. It must also protect the taxpayer to the maximum extent possible, and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and run effectively."Broad impact:
"This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and stimulate our economy."
In his testimony before the U.S. Senate on September 23, 2008, Fed Chairman Ben Bernanke also summarized the rationale for the bailout:Investor confidence:
"Among the firms under the greatest pressure were Fannie Mae and Freddie Mac, Lehman Brothers, and, more recently, American International Group (AIG). As investors lost confidence in them, these companies saw their access to liquidity and capital markets increasingly impaired and their stock prices drop sharply." He also stated: "Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions. More generally, removing these assets from institutions’ balance sheets will help to restore confidence in our financial markets and enable banks and other institutions to raise capital and to expand credit to support economic growth."Impact on Economy and GDP:
"Extraordinarily turbulent conditions in global financial markets... these conditions caused equity prices to fall sharply, the cost of short-term credit—where available—to spike upward, and liquidity to dry up in many markets. Losses at a large money market mutual fund sparked extensive withdrawals from a number of such funds. A marked increase in the demand for safe assets—a flight to quality—sent the yield on Treasury bills down to a few hundredths of a percent. By further reducing asset values and potentially restricting the flow of credit to households and businesses, these developments pose a direct threat to economic growth."
Regarding the $700 billion number, Forbes.com quoted a Treasury spokeswoman: "It's not based on any particular data point. We just wanted to choose a really large number."
According to CNBC commentator Jim Cramer, large corporations and institutions are pulling their money out of bank money market funds, in favor of government-backed Treasury bills. This move is slowly taking away the capital reserves the banks have grown to depend on. Cramer called it "an invisible run on the banks," one that has no lines in the lobby but pushes banks to the breaking point nonetheless. Bank runs are taking place under the radar, he said. Chief financial officers, lawyers, the wealthy – they’re all pulling their money from savings accounts and asking for T-bills. As a bank’s deposits evaporate, so too does its ability to lend and correspondingly make money. This will continue until Congress agrees on a bailout deal. “The lack of confidence inspired by Lehman’s demise, the general poor health of many banks, this is going to turn this into an intractable moment,” Cramer said, “if someone in the government doesn’t start pushing for more deposit insurance.”
Reaction to the initial proposal
Skepticism regarding the plan occurred early on in the House. Many members of Congress, including the House of Representatives, did not support the plan initially, mainly conservative free-market Republicans and liberal anti-corporate Democrats. Alabama Republican Spencer Bachus has called the proposal "a gun to our head" fear-inflicting policy of the administration to stifle proper debate and affect decision. However, many sources have reported that for this crisis there are many alternatives and options, and other less risky and more profitable solutions to use the taxpayers' funds that aren't being debated, but ought to be debated, in the rush to the sudden deal.Immediate [controlled-faux] market reactions [controlled by the same illuminati bankers]
On September 19, 2008, when news of the bailout proposal emerged, the U.S. stock markets surged by approximately 3%. Foreign stock markets also surged, and foreign currencies corrected slightly, after having dropped earlier in the month. The value of the U.S. dollar dropped compared to other world currencies after the plan was announced. The front end oil futures contract spiked more than $25 a barrel during the day Monday September 22, ending the day up over $16. This was a record for the biggest one-day gain. However, there are other factors that caused the massive spike in oil prices. Traders who got "caught" at the end of the October contract session were forced to purchase oil in large batches to cover themselves, adding to the surge in prices. Further out, oil futures contracts rose by about $5 per barrel. Mortgage rates increased following the news of the bailout plan. The 30-year fixed-rate mortgage averaged 5.78% in the week before the plan was announced; for the week ending September 25, the average rate was 6.09%, still far below the average rate during the early 1990s recession, when it topped 9.0%.
Potential conflict of interest
There was concern that the current plan created a conflict of interest for Paulson. Paulson was a former CEO of Goldman Sachs, which stood to benefit from the bailout. Paulson has hired Goldman executives as advisors and Paulson’s former advisors have joined banks that were also to benefit from the bailout. Furthermore, the original proposal exempted Paulson from judicial oversight. Thus there was concern that former illegal activity by a financial institution or its executives might be hidden.
The treasury staff member responsible for administering the bailout funds is Neel Kashkari, a former vice-president at Goldman Sachs.
In the Senate, Senator Judd Gregg (R-NH) was the leading Republican author of the TARP program while he had a multi-million dollar investment in the Bank of America.
Views from the public, politicians, financiers, economists, and journalists
Protests opposing the bailout occurred in over 100 cities across the United States on Thursday September 25. Grassroots group TrueMajority said its members organized over 251 events in more than 41 states. The largest gathering has been in New York City, where more than 1,000 protesters gathered near the New York Stock Exchange along with labor union members organized by New York Central Labor Council. Other grassroots groups have planned rallies to protest against the bailout, while outraged citizens continue to express their opposition online through blogs and dedicated web sites.
In a survey conducted September 19–22 by the Pew Research Center, by a margin of 57 percent to 30 percent, Americans supported the bailout when asked "As you may know, the government is potentially investing billions to try and keep financial institutions and markets secure. Do you think this is the right thing or the wrong thing for the government to be doing?"
In a survey conducted September 19–22 by Bloomberg/Los Angeles Times, by a margin of 55 percent to 31 percent, Americans opposed the bailout when asked whether "the government should use taxpayers' dollars to rescue ailing private financial firms whose collapse could have adverse effects on the economy and market, or is it not the government's responsibility to bail out private companies with taxpayers' dollars?".
In a survey conducted September 24 by USA Today/Gallup, when asked "As you may know, the Bush administration has proposed a plan that would allow the Treasury Department to buy and re-sell up to $700 billion of distressed assets from financial companies. What would you like to see Congress do?", 56 percent of respondents wanted Congress to pass a plan different from the original Paulson proposal, 22 percent supported the Paulson proposal in its initial form, and 11 percent wanted Congress to take no action.
Senator Sherrod Brown said he had been getting 2,000 e-mail messages and telephone calls a day, roughly 95 percent opposed.
As of Thursday September 25, Senator Dianne Feinstein's (D-Calif.) offices had received a total of 39,180 e-mails, calls and letters on the bailout, with the overwhelming majority of constituents against it.PoliticiansThen-senator Barack Obama addresses the Senate on the financial crisis and argues in favor of the bailout bill. View clip on commons. "Barack Obama support of Bailout". Retrieved 2008-10-16.
British Prime Minister Gordon Brown supported the plan, saying that it was essential to restore stability to the markets.
The then presidential candidates from both major parties, Senators Barack Obama (D) and John McCain (R) voted in favor of the Senate version of the bill on October 1, 2008. Senator Barack Obama pledged to telephone wavering House of Representatives members to urge them to support the legislation.
"This plan is stunning in its scope and lack of detail," said Connecticut Senator Christopher Dodd, chairman of the Senate Banking Committee. "It does nothing in my view to help a single family save a home."
"I am concerned that Treasury's proposal is neither workable nor comprehensive, despite its enormous price tag," said Alabama Senator Richard Shelby, the ranking Republican on the committee.
"The Paulson plan will not bring a stop to the slide in home prices. But the Paulson plan will spend 700 billion taxpayer dollars to prop up and clean up the balance sheets of Wall Street. This massive bailout is not a solution. It is financial socialism and it's un-American," said Sen. Jim Bunning, R-Ky.
Then Democratic presidential candidate Barack Obama said any bailout must include plans to recover the money, and protect working families and big financial institutions and be crafted to prevent such a crisis from happening again.Texas Republican U.S. Representative and former two-time presidential candidate Ron Paul publicly opposed any bailout and called for other type of reforms to remedy the crisis.
Ohio Democratic U.S. Representative Dennis Kucinich, a former two-time presidential candidate, delivered a speech on the House floor denouncing the bailout as "too much money, in too short of a time, going to too few people, while too many questions remain unanswered," and asking, "Is this the U.S. Congress or the board of directors at Goldman Sachs?"
Democratic opponents of the bailout include Oregon U.S. Representative Peter DeFazio, who called for a modified Tobin tax on stock transactions to pay for any bailout, and California Congressman Brad Sherman, who compared the bailout to a ransom demand for "$700 billion in unmarked bills".
Republican opponents of the bailout include Texas U.S. Representative Ted Poe, who gave a speech on the House floor comparing the dire economic warnings of the bailout's proponents to the Y2K scare, and Michael C. Burgess, who accused the House leadership of declaring "martial law" to pass the legislation without debate.
After negotiations, bipartisan groups of Congressional leaders were willing to support the highly revised plan. Despite the leaders' support, the rest of the House of Representatives did not follow their lead.
In a Wall Street Journal opinion piece, Senator Hillary Clinton has advocated addressing the rate of mortgage defaults and foreclosures that ignited this crisis, not just bailing out Wall Street firms: "If we do not take action to address the crisis facing borrowers, we'll never solve the crisis facing lenders." She has proposed a new Home Owners' Loan Corporation (HOLC), similar to that used after the Depression, which was launched in 1933. The new HOLC would administer a national program to help homeowners refinance their mortgages. She is also calling for a moratorium on foreclosures and freezing of rate hikes in adjustable rate mortgages.
Libertarian presidential candidate Bob Barr has been one of the most outspoken opponents of the bailout. He spoke out against it while it was making its way through Congress. He took his message to the airwaves and explained the government should not toss around taxpayer dollars so easily and that government should decrease regulation and privatize Fannie Mae and Freddie Mac.Financiers
Investor Warren Buffett
says he could put in $10B plus $90B nonrecourse debt; that is, without having to repay beyond $10B if mortgages did not repay. (This is 10 to 1 leverage, 10 times upside with 1 times downside.) He also said that the government should pay market price, which may be below the carry value. Buffett says "I would think they might insist on the directors of the institutions that participate in this program waiving all director's fees for a couple of years. They should, maybe, eliminate bonuses." Buffett says "...if someone wants to sell a hundred billion of these instruments to the Treasury, let them sell two or three billion in the market and then have the Treasury match that, ... . You don't want the Treasury to be a patsy." Mr. Buffett's company owns financial companies which will benefit directly or indirectly, including his investment in Goldman Sachs.
Alan Greenspan, former Chairman of the Federal Reserve, endorsed Paulson’s plan on September 19.
Investor George Soros
is opposed to the original Paulson plan – "Mr Paulson’s proposal to purchase distressed mortgage-related securities poses a classic problem of asymmetric information. The securities are hard to value but the sellers know more about them than the buyer: in any auction process the Treasury would end up with the dregs. The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief." – but calls Barack Obama's list of conditions for the plan "the right principles".
Investor Carl Icahn described the bailout as "crazy and inflationary hell".
Investor Jim Rogers called the plan "astonishing, devastating, and very harmful for America".
Tim McCormack (Chief Investment Officer, Alpha Titans, Santa Barbara, CA) has diagnosed the underlying problem as a failure of regulatory oversight, which allowed firms to overly leverage mortgage-backed assets. He criticizes the Paulson Plan as a giveaway. He has also written that fears of the domino effect, rather than illiquidity, are the cause of the credit freeze.
William Seidman was critical of rescuing the banks' managements and their shareholders, comparing the bailout with action he and his team at the Resolution Trust Corporation took during the S&L crisis of the 1980s: "What we did, we took over the bank, nationalized it, fired the management, took out the bad assets and put a good bank back in the system."
In an open letter sent to Congress on September 24, over 100 university economists expressed "great concern for the plan proposed by Treasury Secretary Paulson". The letter, endorsed by 231 economists at American universities within a few days, has been described as "the emerging consensus from academic economists". Its authors described three "fatal pitfalls" they perceived in the plan as it was initially proposed:
1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. [...] The government can ensure a well-functioning financial industry [...] without bailing out particular investors and institutions whose choices proved unwise.
2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.
3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.
Nobel Prize-winning economist Joseph Stiglitz strongly criticizes the bill in an article written for The Nation.
Economist, New York Times columnist and Nobel laureate Paul Krugman
recommended that, instead of purchasing the assets, equity capital could be provided to the banks directly in exchange for preferred stock. This would strengthen the financial position of the banks, encouraging them to lend. Dividends would be paid to the government on the preferred shares. This would be similar to what happened during the S&L crisis and with the GSE bailout. This avoids the valuation questions involved in the direct purchase of MBS. This is an approach based on the 1990s Swedish banking rescue. But then he still endorsed the plan and said that congress needed to pass it because they had to do something.
The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economists to argue that buying preferred stock will be far less effective in getting banks to lend efficiently than buying common stock.
A recent study shows that market's reaction to the announcement of a rescue plan is positive independently to the type of the intervention. It indicates that a timely bad plan could be better than an untimely good one.
The Economist magazine said that although "Mr Paulson’s plan is not perfect ... it is good enough" and that "Congress should pass it—and soon."
"The deal proposed by Paulson is nothing short of outrageous. It includes no oversight of his own closed-door operations. It merely gives congressional blessing and funding to what he has already been doing, ad hoc." - Robert Kuttner
Journalist Rosalind Resnick favors a hypothetical scenario in which "consumers and businesses would be able to borrow at the fed funds rate at 2 percent, just like the big banks do. This means that every cash-strapped homeowner would be able to refinance his mortgage and cut his payments in half, saving thousands of homes from foreclosure. Consumers could also refinance their credit card balances, auto loans and other debt at interest rates they can afford" and that this plan "would cost U.S. taxpayers absolutely nothing."
Journalist Michael Hudson says "It is bad enough for the government to buy $700 billion of bad bank investments at prices that no private-sector investor has been willing to approach. This itself is an undeserved giveaway to the financial institutions that caused the problem..."
And now we know it was not $700 Billion, but over $28.3 Trillion.