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The Real Impact of the Plan

Posted by: Michael Mandel on September 21

We now know the first version of the big bailout plan. It gives Paulson virtually unlimited authority to buy and sell up to $700 billion in residential and commercial mortgages, and related securities. Right now the proposal is focused on U.S.-headquartered financial institutions, but that could expand.

So the question now is: Who wins? Who loses? What is the real impact of the plan?

Here’s my analysis. Over the past ten years, Americans overspent by roughly $3 trillion. Which Americans? It’s hard to say. In some cases people borrowed against their homes and spent more than their incomes justified on SUVs and big screen televisions. Part of the overspending came in the form of too many big homes, built in too many suburbs. Part of it came from excess spending on health care, both by families and by the government.

The truth is, we can’t really figure out who overspent. We just know that it happened.

So we have all this excess debt that we can’t afford to pay back, or at least not easily. So somebody is left holding the bag. Financial institutions have absorbed big losses, but they (or their investors)have reached their limit.

So who bears the rest of the losses? Keep in mind that ultimately that $3 trillion in excess debt is owed to the rest of the world, who lent it to Americans, who in turn used it to buy imported goods and services.

So if the debt is going bad, either Americans will bear the losses, or foreign lenders (including many central banks). That is, either Americans dramatically reduce their consumption (and imports!) in order to pay back the loans, or foreign lenders accept that the loans that they made are worth a lot less.

Neither alternative is palatable. The first one would mean a very sharp recession. The second would probably mean a flight away from dollars, a sharp increase in interest rates, and a recession as well. Both alternatives would lead to a sharp drop in imports, and probably global recession.

So what does the plan do? The plan effectively turns mortgage securities into treasury securities, fully backed by the U.S. government, at some discount. It inflicts pain on foreign lenders, but it says: “We are responsible. We will guarantee the rest of the debt.”

So the real impact of the plan is that it maintains the flow of capital from overseas, and allows Americans to keep borrowing to pay for imports, backed up now by the full weight of the U.S. government and its ability to levy taxes.

In effect, the Paulson-Bernanke plan maintains the current structure of the global economy, where U.S. borrowing helps pay for consumption in the U.S. and investment elsewhere.


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Reader Comments

A. Vijayaraghavan

September 21, 2008 09:54 AM

Increasing exports to the countries America owes is one option that I think should be looked at.


September 21, 2008 03:48 PM

In all the fancy verbiage and proposals, the proposals is just one shifting debt from all those who took on too much debt - over to the taxpayers, most of whom never profited from the Ponzi schemes.

The proposal contains no measures to require saved banks to compensate the taxpayers. It merely bails out the reckless criminals of wall street and punishes innocent Americans with an economic martial law that cannot be challenged in the courts or by any government agency.

Mike Reardon

September 21, 2008 05:03 PM

Putting it all on consumer debt is not right. There is now an active iceberg of debt below that $3 trillion. It was created over this same time period by hedge funds leverage and corporations using there inflated stock valuation as collateral in mergers and acquisitions of rival firms.

Those exotic debt instruments now add hundreds of trillions in debt outside housing. When the stock market fell from 14,000 there lower valuations can be seen as the same as deflating housing costs. That seems to be part of the AIG's problem.

It may be housing is the point of firming that will support the whole, but now everyone sharing the pain has to be evenhanded. It may end with the need to undo what is put in placed on the first round of action. Where to place the support should not be totally in the hands of an agency with absolute powers.


September 21, 2008 10:29 PM

Wait a minute, I thought I was keeping up with the data flow, but I missed the part about how much of the excess $3 trillion in consumer debt is held by foreign nations and investors. There is an implication in what you say that the latest scheme is aimed primarily at saving foreign holders of the toxic mortgage instruments. I doubt that is quite what you meant, at least I hope so, because that would make the whole deal look a lot scarier.

Did somebody tell our pension fund managers, our municipalities, our insurers, our university endowments not to buy these packaged debt instruments? Clearly, nobody told certain domestic money market managers -- that's why the sacred $1 valuation was threatened when scared investors began to leave. Clearly nobody told AIG.

Nobody told me that they were inside a so-called short term AAA bond fund, in fact I was told specifically that they weren't there, until I was told that -- oops -- they were, after the price began to plunge dramatically. You have not heard me crying for a personal bailout, although I'm certainly willing to participate in the class action suit.

Let me believe that the value of these toxic assets will be stabilized at a reasonable level for all. In the meantime, if housing is dropping so dramatically as to drive this crisis, why doesn't my county know it -- they continue to push up assessments and taxes by 12% and more every year.

Joe Cushing

September 22, 2008 01:55 AM

Aren't there surveys that can tell us who the over-spenders are? It would be the same people who are in debt.

Even if "the plan" works, that doesn't sound like a good outcome either.

I think a lot of Americans might spend less if they can learn from their mistakes. That's a big IF though.

Josh, Texas

September 23, 2008 02:56 PM

Just an FYI… according to the IRS 2007 Data Book, there are 139 million individual tax filers in the US (pg 5). According to the Tax Foundation, around 33% of those individuals have zero liability at the end of the year.
That means there are roughly 93 million paying taxpayers in this country. Thus, if the 700 billion “bailout” dollars were given to contributing taxpayers instead of the treasury, they would get $7527 each.
Interesting huh? (Compiled using sources from Wikipedia).

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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