State of the Union

After a 263-171 vote by the House of Representatives on Friday, President Bush signed legislation aimed at rescuing the freezing credit markets in an effort to shore up the failing economy. That means that American taxpayers are now the proud owners of a $700 billion bailout! Yes, that’s not a typo, it is in BILLIONS of dollars.

I didnt know that kind of money even existed now!

The sad part is, it’s a bit (read: a lot) bigger than $700 billion. The version of the bill that passed Friday contains some expensive add-ons. It also raises the US debt ceiling to over $11 trillion.

There are some pretty dubious additions as well. Protecting production of wooden arrows? Really?

How does it work?

The bailout plan gives the US Treasury extremely broad authority to buy up to $700 billion in troubled assets (such as those mortgage-backed securities, you know, the ones that really have a chance at turning around) from companies that are having difficulty selling them. Uncle Sam can also insure these assets instead of buying them, you know, for fun. 

The main idea is to get these securities off companies’ books, or at least give them a government guarantee, so that these businesses can more easily lend and borrow again. This makes it easier for involved businesses to help pay their $100 million executive settlements. We all know they really deserve it.

Only assets that were originated on or before March 14, 2008, are eligible. The Treasury has through 2009 to use the funds.

Once the bill becomes law, the Treasury will hire a team of consultants and managers to help the government figure out what to buy, hence the high “administrative” costs discussed later. This group will also assist the Treasury in determining how to price the assets, which are now tough to value (~$0). The most likely scenario is an auction. The Treasury could sell the securities for a profit (haha) at a later date.

If there is a net loss, in 2013, the president will have to come up with a report to recoup the shortfall–however, only an act of Congress can put that plan in place.

Accountability?

The Treasury secretary would periodically submit to Congress a detailed report of the bailout’s progress, including all financial transactions and the “types of parties involved.” In addition, every quarter, a special inspector general would provide Congress with a report including all purchases made and income received from the bailout.

Figure 1: Special Inspector

How much will it cost?

The initial addition to the federal debt would be $700 billion, although the Congressional Budget Office believes the net budget loss will be “substantially smaller” because the government can recoup some of its losses and perhaps sell the securities for a profit later (yes, this still includes those really awesome same mortgage-backed securities).

Oh, and there are also administrative costs (of course), which the CBO currently estimates at perhaps “a few billion dollars per year.” Peanuts, really….

Adding to this, the newly added tax provisions of the bill alone will cost the government an additional $110.4 billion by 2018, according to a just-released study by Congress’ Joint Committee on Taxation. The funny thing? Only $3.4 billion of that is related to the “bailout” portion of the bill.

What happens to the companies that participate?

They will have to give the government the ability to acquire shares and executives at the companies will be subject to more restrictive compensation rules. There is the possible stigma of participating, since it may make them appear to be weak. But if everybody does it.

What’s the best-case scenario?

That credit markets start functioning properly again, and the government can turn a profit on the sale of the assets it buys.

Figure 2: Where the best case scenario will take place

That doesn’t mean the U.S. economy will become healthy again overnight, however. Stephen Auth, chief investment officer for Federated Investors, says to expect more bad economic news for at least the next couple of quarters, including unemployment levels at 7% or higher. “This is going to throw up a breakwater and keep it from swamping the whole system,” he says of the bailout.

What’s the worst case?

It simply doesn’t work. Credit markets remain gummed up, borrowing and lending for consumers and businesses of all sizes come to a halt and banks continue to fail. That could lead to a prolonged recession.

There’s also the possibility that the expansion of insurance caps on bank deposits won’t do much to help small businesses, which typically need to insure more than $250,000.

In addition, if the government can’t make any money from the purchase of these assets, it saddles Americans with more debt and higher interest rates, perhaps for years to come.

Is there a Plan B?

No. I mean, if they are spending $700 billion +, it should be almost guaranteed to be successful, right?

/end sarcasm

But realistically, now that Congress has passed a bailout package, it will almost certainly not give the administration any more money to rescue the economy.

 

I hope this cheery guide helps you understand the clusterfcuk that is going on down there, since it DOES have a pretty significant impact on us as Canadians.

 

Brodie