How the $700B Bailout Turned Into $7.7 Trillion
Bloomberg reported that the Federal Government has now committed to throwing even more money at the economic crisis, to try to unfreeze the credit markets. And that’s equal to half the GDP from last year. It’s a big number.
You know from previous posts that I was a fan of the original bailout bill. The simple explanation was that investors bought into pools of loans through Mortgage Backed Securities (MBS) and other instruments that have always had a built-in default rate of 1%. When defaults of some of those loan pools spiked to 4%, those investors freaked, and the market began to melt-down; or freeze up, depending on the metaphor that your prefer.
On the street, people said, “You mean 96% of mortgages are still performing well? What is the big deal? Why all this talk about a crisis?”
But, look at it from the investors point of view, and you will see why I was in favor of the bailout. The default rate increased by 400%, thus diluting their returns on what should have been a safe, secure and predictable investment. That becomes intolerable.
Send in the Cavalry
So, Bernanke, Paulson and Co., with the backing of Congress, rode in to save the day. They would buy these troubled asset pools – supposedly for a steep discount. And banks and others get rid of those troubled assets, tighten their lending guidelines for new loans (which has already happened), ensuring that the same ‘subprime’ problem does not repeat, and everyone is happy again. Even the taxpayer, assuming the government bought the troubled asset pools that are performing at 94-96%, for, say, $.40 on the dollar. An easy solution where everybody wins.
And if that had happened, I would have given Paulson a ‘High Five’.
Alas, it did not.
As the Bloomberg article linked above states, the Fed is not really disclosing where the money is going, who it is being lent to, and what the government is getting in return.
What Do You Do Now
One thing is for certain – Inflation is just around the corner. And it won’t be comfortable. So, trim outgoing expenses now. You can make a list of the outgoing expenses to trim as a household. From a macro perspective, look at your mortgage and other debt:
- If you have an Adjustable Rate Mortgage (ARM) that is going to adjust in the next year, switch to a fixed rate or another long term ARM now. As inflation hits, the only effective weapon against inflation that the Fed has is to raise interest rates. And they raise the Fed Funds rate, which has an indirect effect on the Indices that adjustable rate mortgages are tied to. So, LIBOR and the others will rise along with the Fed’s actions. Refinance now; you will be glad you did.
- If you have credit card debt and car loans and you have equity in your home, you will want to strongly consider consolidating all of that into a new home loan. You get the tax benefits, a lower interest rate on that debt – and most importantly you get increased cash flow. And, as of January 1, FHA loans will do a cash-out refinance to 100% of your home’s value.
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