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Godot's Page: Economics Explained

Godot's Page

Gatekeeper to the Theater of the Absurd

Thursday, 25 September 2008

Economics Explained

Recently, the Sandmonkey voiced his opinion regarding the bailout plan and described it nicely in his opener as “the most ridiculous hit I’ve ever seen in my life.” If he were to argue about the methodology, or the rationing of the bailout fund, then this post would be redundant. But an adamant rejection of a bailout in principle reflects a general unawareness of the various stakeholders in play.

First off, the ‘make a quick buck’ mentality is not the primary cause of the housing bubble. The ‘make a quick buck mentality’ underpins the golden foundation of capitalism via arbitrage; it is the irrationality of the consumer in an appreciating market that causes prices to rise and fall. The real causes of the bubble were the low prevailing interest rates and the generally lax lending requirements enforced by banks in the last half decade. I digress, back to the bailout:

AIG insures approximately $1 trillion of consumer assets including, but not limited to, houses, mortgages, lives, and cars. Imagine one day, hurricane Ike hits your house which you’ve bought using your hard earned money. You call up AIG to claim your home insurance cheque and you get an answer you don’t want to hear…you subsequently get a heart attack because you just realize that all the money you’ve invested in the stock market has gone down the drain, and the only asset you owned has been reduced to rubble because of a natural disaster which you’ve insured yourself against and have been paying the premiums on for the past decade and a half…that also goes down the drain. When your funeral is over (b3eed ilshar), your next of kin receives a phone call from an AIG rep saying that she will receive compensation in the form of a massive zero. Your next of kin stages a protest along with the 100,000 other people living on the coastline of your town affected by Ike, who also had insured at AIG. The mayor says “look guys, there’s no money here, its all being spent on tanks and school buildings in Afghanistan.” Your next of kin picks up a shotgun and goes on a rampage because she loses faith in the system. By arguing against a bailout, you are arguing for this, and many more less sensationalized scenarios to occur.

As far as you pointed out in argument 10), the good ‘ol American who is paying his mortgage on time and in full amount who gets charged a higher rate now that markets have gone to shit has alr3eady factored that risk when he signed the loan doc which stated a floating interest rate of LIBOR+x%. The libor part is floating, thus the argument is invalid. Also, see paragraph above.

So, in short, the bailout plan is designed to help banks and financial institutions de-lever their balance sheets – i.e. reduce debt levels – not to bolster profits in an evil capitalist conspiracy. The payouts per institution on the bailed out entities will trickle down the capital structure, from secured lenders, to bond holders, to finally, equity holders, who will surely get nothing after liquidation. More stakeholders (ie good ‘ol Americans) will be saved than if you leave this crisis untouched. Finally, bailouts in the form of nationalization (see Fannie and Freddie, and AIG) as well as aid, gives the Federal Reserve the right to inspect the companies’ books at any time it chooses to do so, thus reducing the risk of hiding away risks in piles of collateralized securities.

For my views on the moral hazard of picking and choosing what to bailout, see my next post, I have a one page policy per post in effect here.



Anonymous Canicula said...

"and the generally lax lending requirements enforced by banks in the last half decade."

And you don't think that this was motivated by the attempt to wring the last cent out of the market, 'maximise shareholder value' and ensure fat bonuses all round? That's usually equates to greed.

01 October, 2008  
Blogger Godot Basha said...

I dont agree with the way you framed that. If everyone really wanted to be 'greedy', they wouldn't have lent that much money to bad debtors. Due to their lack of efficient greed-seeking, lenders now have to cope with defaults on their loans, not the smartest thing to do if you're looking to 'wring the last cent out of the market, maximise shareholder value, and ensure fat bonuses.

06 October, 2008  

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