LookieNoNookie
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So I came up with the below for a very good friend of mine. She was curious how I (and the economy) was doing....
She asked me...."Is this bail out going to fix the problem"....and...."will it help your business?"
And so.....
"Is the bail out going to fix everything....and will it help your business?"
"It will do some things well, but largely it's a wash as to what it actually does, and ultimately it won't solve the immediate (36 months) problem, which is the tightening of credit.
It's complicated for most, but the basics are: Banks loan money. They do this through something called "reserve requirements".
This means that banks and lending institutions are required to keep "in reserve" a specific amount of the money they lend out. Let's say this is 10%.
So, if they have 10 dollars, they can loan out 100.
They (banks) don't manufacture money out of thin air (although the federal reserve does), they borrow it from the federal reserve or other banks at what are called "overnight rates", which is typically the same rate as what's called "the discount rate", or what the federal reserve lends money to other banks (currently 2%).
There is another rate structure, called LIBOR, or "London Interbank Offered Rate", also commonly called the London Interbank Overnight Rate, since it's the worlds official "interbank" (bank to bank) lending rate.
Essentially, it's the rate that all other banks typically lend to each other at, and it almost always is within a fraction of the federal discount rate (again, currently 2%).
It's also the rate wherein which many ARM (variable rate) mortgages are written on top of. (This is a problem!).
As of this moment the LIBOR rate (bank to bank loan rate) is almost double the federal discount rate. The difference is called "the spread".
When the spread is so opposed to the federal discount rate (since regardless of other govt. rates around the world, the US Dollar is what's called a "reserve currency", which means most people buy and sell money and goods based on US rates/valuations) it's an indication that banks aren't willing to lend money to each other.
In fact, while the current short term LIBOR is above 4%, current loans are taking place (bank to bank) worldwide at rates in excess of 8%.
Why is this happening?
Because banks lend against assets, whether to you and I over a car or a home, or to banks, against assets, in their case, loans outstanding, owed to the bank in question...ergo, an asset. Except that the loans held and in question, are suspect.
So much so that there is a requirement by the SEC that demands that loan portfolios are "marked to market".
I owe you 100 dollars. The payment due each month is 1 dollar. I'm a car dealer, and the rumor is I'm going broke and will likely default on my loan to you. You want to sell that loan and get out of it.
You determine that 50 bucks today is much more valuable to you than 100 dollars (assumed, and it would appear...somewhat risky) at some later date.
I still haven't missed a payment and assure you in writing that I won't....but I sell cars, and all the other banks in town that could buy that loan from you have heard rumors that I've been letting salesmen go, and....there are now 40 new cars on the lot where there once were 240....clearly all signs are that I won't be in business much longer.
So, the market (other banks) come to you and say "I'll give you 50 dollars for that 100 dollar loan (asset). You sell the loan and now have 50 dollars. You're quite happy.
Why? Because you now have 50 very real dollars.
The other fellow has an asset he values at 50 dollars, but it's paying off as though it was still a 100 dollar asset...and hopefully for a very long while to come.
The loan previously was on your books at 100 dollars (which, remember, the SEC made you write down to 50 dollars...except...that loan wasn't actual cash, which meant no other banks would loan you even 20 bucks against it), which you could previously borrow 1,000 dollars against (10 to 1, remember...the reserve requirements?) and therefore loan out. Now you have 50 real dollars worth of real assets to borrow against...to loan out.
In the above, the guy that bought that loan from you is the federal govt.
The bank (you) is every other financial institution on the planet that has or will sell distressed loans to create a viable asset.
Today they have a questionable asset, valued at 50 bucks (because the feds require that you "mark to market"), even though it's paying off as though it was still 100 dollars.
But you're not in the business of being a nice guy...your job is to loan money, and you can't borrow enough reserves against your questionable assets...because no one can be sure that asset is in fact actually worth a dollar, hence your assets are questionable enough that the other financial institutions now don't trust YOUR (a banks) ability to repay.
Hence why LIBOR increases, even as world asset prices and discount window rates decrease.
Once the bad asset is gone (replaced by a good one of the same value), banks will begin loaning to each other (albeit against a significantly smaller asset base) and loans, while much more restrictive, and only to folks with exceptional credit scores and histories, will become available again (I'm guessing we'll begin to see credit flowing somewhat better by next year about this time...October 2009).
The reason why banks aren't eager to loan money to each other right now (which is where they get the money to loan to you and I) is...they simply can't validate exactly what the asset is worth.
So...it's worth...less.
Once the feds buy it, giving the bank in question a quantifiable asset to loan against (green cash), they can then borrow...and at rates that will be distinctly below those offered today.
But here's the rub....
Everyone watching the news thinks that this deal makes the problem go away...and the facts are, the banks still end up with a worth....less asset.
Which means they have less to borrow against, and with less to borrow against, they have less to loan out.
With less to loan out, to be able to pay their bills (their overhead established back in the day when they made twice as much...only months ago), they have to charge a lot more to stay even.
This makes credit vastly more expensive for the average little guy on the street, meaning he'll end up borrowing less.
This means he's also buying less as well.
70% of our GDP (our economy) comes from debt. The ability to borrow to build, invest, etc. also comes from this same debt. (It was 24% of the economy 35 years ago).
If the average business guy has to charge more (because his debt costs more as well as he now moves less of his product {requiring him to charge all the more}...but still has the same overhead), costs go up.
His costs go up.
And with every notch up in margin he requires...he loses a few more customers. Requiring ever more margin once again.
Is the bail out plan going to work? Yes. For what it's intended to fix, absolutely. But it's not intended to help the average guy on the street (even though that's what the papers will continue telling you).
Will it save the economy? Unfortunately not. But, as the Prez said, it is better than doing nothing.
The economy must go through some gut wrenching changes over the next 5 years, this (bail out) will make the pain only slightly less.
Imagine we've just been in an incredibly horrifying car accident. Many people died. 6 survived, all of them with multiple and severely broken bones
6 called home.
The bail out is not a Star Trek scanner where everyone is taken to sick bay and in minutes each have brand new bone structure created by Dr Scott and in 2 hours are back at their posts, fully recovered.
The bail out is 3 single 500 mg aspirin pills.
There are no Tylenol #4's to be found...just these 3 aspirin.
For 6 very incredibly, in some case horrifically, damaged people.
For the 3 that get the aspirin, rest assured, those 3 are very happy they aren't the 3 that didn't get aspirin.
But the aspirin's going to wear off very quickly (by about February of 2009 as best as I can tell) and while all 6 are expected to fully recover and heal....only 3 got temporary relief, and pretty soon even they won't be able to disguise the pain any longer.
Will it help my (or other) business? Probably".
Carry some aspirin.
< Message edited by LookieNoNookie -- 9/28/2008 4:24:18 PM >
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