Monday, October 6, 2008

HERE'S THE SKINNY ON THE BAILOUT

Hey Kids!

Sorry for the intrusion. It’s been a nutty week – I have been on more radio stations and networks than I care to remember talking about the economy this week. I have been getting a ton of emails and calls asking for an explanation of what is going on with this "bailout" or "rescue plan" and I wanted to provide some insight into the situation. Here is the best explanation.


The Plan

What the government wants to do with the new bill in congress is to provide liquidity to the market. The politicians have done a pretty bad job of explaining what is going on, and the vast majority of Americans believe that this bills sole purpose is to "bail out" the big business that screwed up in the first place. Since there is so much overwhelming opposition to the bill from constituents, and since we are SO close to many of the same representatives voting on this bill facing re-election, it gets really politicized.

What the Government wants to do is provide a market for the questionable assets and clear up the banks balance sheets so that they can continue to operate and lend money to consumers, small businesses, etc. The government is the ONLY investor at this point that can step in at this point. The main point is that the government can purchase these assets NOW at a very discounted price, and once the market returns, the plan is to sell the assets back and make a profit for the American people on their investment.

The banks are currently in a bad position like - they are in duress, and need to sell their assets.

The Consequences

The misconception is that this bill is aimed at "bailing out" the financial powerhouses on Wall St. The real issue has to do heavily with normal Americans. The now frozen credit market is the same market that companies, big and small go to for their business lines of credit. It's the same market that we need for our Auto loans, mortgages, credit cards, etc.

If the credit markets remains frozen, it will affect us in many ways. Many business owners use credit lines to pay payroll, order materials, etc. If credit freezes up, jobs will be lost because of the lack of ability to make payroll. If materials cannot be ordered to produce products, businesses will shut down. If the majority of Americans can't get auto loans, they can't buy cars. If they can't buy cars, the already struggling auto makers will shut down plants, and cause more job loss... No one really knows what the outcome of this will be, but it seems to me that the consequences of inaction are far further reaching than those of the action deemed necessary at this time.

The Blame

First of all, the credit markets are frozen. Who is to blame for this situation? Toxic Mortgages? Corporate Greed? Well, partially. But one thing that you might not have heard about that is key is an ACCOUNTING rule called "Market to Market", or the technical term FASB 157 (Pronounced "fasbie 157"). Formed in an effort to provide more transparency, FASB 157 states that every day, lenders are required to evaluate and disclose what they are worth in the marketplace, based on where prices are.

Let’s say a bank is worth 1 million dollars (keep the math simple). They have 15 million dollars in loans outstanding to borrowers. The ratio of loans to assets is 15:1. Now what if a neighboring bank, for whatever reason had to write down some of the same types of assets our bank holds because they got into some trouble. Nothing has changed with our bank, however when we go to disclose the value of our assets, they have fallen because of the other banks actions. For our bank, it is just a paper loss, however, lets say that because of the other bank, our assets are valued at 500K, instead of a million dollars.

The truth is that this crisis has far less to do with quality of loans, than these accounting rules that were passed to increase transparency for investors. 95%of the loans are performing well, however since all loans were packaged together, there is no way to decipher which investments are good, and which are bad.

Lastly,
Lastly, what does this mean for mortgage and rates in the short term? If you ever listen to or watch my show, you know that stocks and bonds compete for the same investment dollar. When the stock market tanked 777 points, money flowed into the bond market, and rates improved. The next day when we rebounded 500 points, that was at the expense of the bond market, and rates went up. My feeling is that the bill will be passed in the House tomorrow, and the stock market should rally pretty substantially. If this happens, it will be at the expense of the bond market, and interest rates should rise...

So, credit is still tough to get because of this freeze, (i.e.: Mortgages are really tough to get unless you are a strong borrower) but we will see what happens if the bill goes through, and rates are still really good. Only 30 months out of the last 360 months have 30 year fixed rates been lower than 6%, so rates are still pretty good if you are lookin'.




Love your show,

Bob "Sully" Sullivan

Thanks for listening to "THE BIG BIZ SHOW WITH SULLY AND RUSS T. NAILZ" nationwide/coast to coast on the BusinessTalk Radio Network weekdays 4-6PM EST! ALSO - CATCH US ON THE FOX BUSINESS NETWORK AND THE WEALTH TELEVISION NETWORK ON A CABLE CHANNEL NEAR YOU!!

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1 comment:

Becky Carroll said...

Great to see you starting a blog, Sully! Just make sure to include some positive stuff, too (when there is some). :)

You rock!