by Key Yessaad - CFO Exit Homeplace Realty
1. Bailout may not be the right term - yes we hear the term all over the news and the plan will help banks shed their "toxic assets" to calibrate their Balance Sheet. An interesting term would be "Government Bridge-Loan." - it conveys the idea that the money is used to buy assets that will be cleaned up and later sold... Many of you understand this concept when you buy a distressed property, fix it up, and then either sell or rent it.
2. Think long term - don't get swayed by the gyrations in the Stock Market: Banks survive by making loans - especially short term loans between banks... these types of loans have come to a grinding halt because banks make loans based on assets (Balance Sheet.) Some of the assets that banks are holding are Mortgage-Backed Securities and no one on Wall Street wants them as collateral. You see these Securities are bundles of mortgages that need to be assessed; some are good some are bad, some are so-so... think in terms of a bushel of apples with a few rotten ones; you have to remove the bad apples to save the rest. The $700 Billion ‘‘Emergency Economic Stabilization Act of 2008'' aims to do that.
3. Think patience and Asset Stabilization: Underneath each of these Mortgage-Backed Securities are properties and each one has a value. The current mortgage on some properties maybe higher than the market value of the property - but it is unlikely that a large number of them are in the same predicament. In a sense this is a Bridge Loan guaranteed and operated by the Treasury to create stability in the financial system.
4. Think respite - not free money: The $700 Billion is a loan by us the Taxpayers to the Treasury to buy assets no one wants, stabilize them, then sell them at the appropriate time. (Again think Bridge Loan!) Many hate the idea of the government interfering in the Capital Markets on a philosophical basis; but that ship has sailed. If more banks fail and liquidity to corporations is not restored, more business failures will occur and more jobs will be lost. The grim predictions you have heard are real...
5. Think liquidity between banks & eventually the consumer: Without liquidity in the financial system corporations will not get the capital necessary to build factories; which are the engine of employment in our nation. The spirit of entrepreneurship will grind to a halt... The essential ingredient in Capitalism is Capital; and it is in very short supply.
6. What is the Stock Market doing? The financial markets are trying to find a bottom... In a sense there are many institutions for which it is too late... Washington Mutual, Wachovia, Lehman Brothers, AIG, etc... The market is trying to figure out who will be the survivors and who is too wounded to survive (it's a bit gloomy but that's how the market works.) Wachovia used to be one of the most conservative banks, but in the Mortgage Frenzy of 2004/2005 they felt they were behind the times and wanted to enter the SIV's market - they did so by acquiring Golden West Financial (practically the inventors of the pay-option mortgage... think about that for a second. A mortgage designed to be paid at the calling to the mortgagee; a mortgage that increases principal versus reducing... talk about a craze in the mortgage business.)
The gyrations in the market are designed to weed out the companies that are too weak to survive. The tough part is the employees of those companies are going to lose their jobs; the deposit accounts are safe.
7. Why is term "Toxic" used so often in this crisis? Mortgage-Backed Securities are bundles of mortgages bought and sold on the Open Market; we are in a period when no one knows what they are constituted of. This lack of pricing ability makes investors stay away from them. Remember Capitalism 101: You have to price something before you can sell it.
Web Link: In layman's terms what does the "$700 Billion Bailout" really mean and how does it help...
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