Yet Another Bailout?
Unless you’ve been in a hole, or cave, the last week I’m sure you’ve heard of the bailout of American International Group, Inc. I’ve already heard the talking heads, man on the street and politicians using this as just another example of the government helping evil mega-corporations but refuse to help poor old John and Jane with their mortgage.
Thus far this year the government has helped or rescued four companies: Bear Stearns, Fannie Mae, Freddie Mac and now AIG. The reason each of these actions was taken was to protect the integrity of the financial system and the country as a whole. Do I completely agree or like these bailouts, no. But I understand that the government needs to take action to protect the whole country and keeping the financial system operating is a key piece to keeping the country, and possibly the world, running.
Helping Joe and Jane with the home mortgage doesn’t benefit the country. It makes for wonderful feel good, but doesn’t help the country or anyone else.
Now I’m not that much of an ass, if the lender was predatory, or the loan was crap then maybe some help was warranted, which by the way was already done by the federal government by freezing interest rate resets. But be realistic, if someone forecloses a home the only people hurt are the family and the mortgage company or bank. The family gets another home or apartment, which they can afford, and the home gets sold.
The extreme of this is if way too may homes start foreclosing. Think about what happens here for a second. People loose their home, but they move on and get an apartment or cheaper house. But now the mortgage company and bank now have this house, which they don’t want. So they sell the house at a fire sale price and move on. The more and more houses being sold at these rock bottom prices being to drive property value prices down in the area. The cycle will repeat, as the fire sale price is adjusted to the property value of the area, the lower it is the lower the price goes.
Liquidity is a term used to denote that something can be easily turned into cash. For example a stock of a highly traded public company like IBM is very liquid. But property like a house is not liquid, because selling a house takes time which selling a stock does not. The state of our current finical system is a two headed dragon of liquidity and confidence.
Liquidity became a problem when the interest rates began to rise and all the sub-prime mortgages began to default. This caused the banks and lenders to start selling the houses at a cheap price, costing the bank and lenders money. This drove down house prices and people began to become “upside down” on their mortgage. Being upside down means that you owe more then your house is worth, and usually a good queue to walk away, i.e. foreclose.
This all trickles up hill as the smaller banks end up having less and less liquidity and can’t pay their obligations to the larger banks, so on and so forth. There have been 11 failed banks this year and the government has not bailed those out. But a saving and loan company is far different then what AIG is. AIG provided insurance for financial products this insurance mitigated risk for those products and thus companies invested in them. Let’s also be clear, AIG wasn’t insolvent, it was illiquid. The loan the government made to AIG will be repaid with interest back to the government and will give AIG operating capital so that it can liquidate those pesky investments and holdings.
Eventually we will see our way through this, we always do. The world is not over and life will go on. We will see more companies and bank fail and those whose failure can pose systematic risk to the financial system will be helped and those that won’t will die.