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Cheat sheet on the bailout thus far

You may remember where we left off last week—the U.S. financial system was melting down like an ice cream cone dropped on a hot sidewalk in August. You might also recall that the Bush administration had just announced a rescue plan. 

After a full week of talk and headlines and Congressional hearings about that plan, lawmakers are in a heated deadlock over the details, furiously negotiating, and the first presidential debate is hanging in the balance. Here’s what’s happening:

In swoops the government
The plan devised by Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke would cost $700 billion, about $10,000 per citizen. Under the plan, the government will buy bad assets from the banks that own them, with taxpayers footing the bill. These are the assets we talked about last week—securities that contain bad mortgages made during the housing bubble. They are so toxic and unwanted that banks can’t unload them—and they’re driving companies into bankruptcy. 

The idea is that the government buys the assets at a cut-rate price and then eventually, when the housing market has bottomed out and we’ve (hopefully) started to recover, the government re-sells them—ideally at a profit, benefiting us average Janes and Joes, but more likely at a loss.

One problem with the plan
Determining what to pay for these assets is problematic. Because the market for them has essentially dried up, no one really knows what they are worth. We don’t want to pay the banks too much—but we have to pay enough so that they can resume normal business, and the economy can begin to function normally. The New York Times described it well: ”What would you pay, sight unseen, for a house that nobody wants, on a hard-luck street where no houses are selling?”  

Some details and the sticking point
Details of the negotiations on Thursday revealed heated exchanges and finger pointing as the Republicans withheld their support of the plan, despite President Bush’s backing. Some fine points of the program include a cap on executive pay at companies that participate in the bailout, and allowing the government to take an equity stake—own a piece—of the banks. In this way, when (or if) these firms recover, their share prices will increase and the government will make money from their holding. 

But Republicans worry that the plan thus far involves too much government intervention in the private sector. There’s also concern over how much power Secretary Paulson would have under the plan.

The big picture
On Friday President Bush said a deal would definitely be reached. Some same the fate of the U.S economy rests on some resolution. At the first Presidential debate Friday night, we’ll get a look at how each of these candidates plans to fix our hurting economy.

The market dominoes

Let’s get right to it—we’re breaking down the wild week on Wall Street, one of the most tumultuous since the Great Depression.

 

In the course of a few days, two storied investment banks effectively ceased to exist and a massive global insurer was taken over by the government—and all this came on the heels of a taxpayer bailout of Fannie Mae and Freddie Mac couple of weeks ago.

Here’s the story in a nutshell:

 

What happened this week

The carnage began last Sunday when Bank of America agreed to buy Merrill Lynch, a huge name in finance that read the writing on the wall and knew it was losing money so quickly that it couldn’t conduct business independently anymore. Merrill sold for $50 billion—61% less than what it was worth a year ago.

 

Then early Monday, Lehman Bros., a 158-year-old financial services firm, filed for bankruptcy.

 

By Wednesday the government stepped in with $85 billion to rescue the nation’s largest insurance company, AIG, from the brink of collapse in an effort to stem a world-wide economic meltdown.

 

Finally, on Friday, with markets still panicky, the Feds played their trump card, proposing a far-reaching program to help prop up the nation’s banks. Details are still to come, but the plan is shaping up to be the biggest government bailout in generations.

 

What in the world is going on?

Quite simply, Merrill, Lehman and AIG are all victims of bad loans made in the housing market—the latest dominoes to fall.

 

You’ll remember that we wrote about this in August 2007 when the markets first started reeling from the sub-prime mortgage crisis (watch this hilarious but foul-mouthed animation for a good explanation) and the collapse of the housing bubble. Basically, bad home loans were packaged up into securities (called mortgage-backed securities, or MBS) and were bought and sold by finance giants around the world.

 

When home prices began falling and people couldn’t meet their loans, the value of these securities fell. Companies with large exposure to these securities were left holding bad assets with no one to buy them—like a stock that was worth $10 that’s now worth 10 cents. The accountants had to “writedown” the value of the securities on company books. Merrill Lynch, for example, has recorded a whopping $51 billion in writedowns, meaning it revalued those soured assets to lower prices, cutting directly into its profit.

 

What we are seeing now is the impact of the losses created by those sickly securities. It’s literally sinking firms.

 

The big picture

Stock markets around the world zigged and zagged. Investors searched for any place safe to park their money, fleeing to commodities like gold and government bonds. Meanwhile, for the first time in years, a major money-market fund—generally the safest of investments—actually lost money. Questions continue to swirl about the government’s decision to bail out the nation’s ailing finance industry.

 

If people agree on anything, it’s that this rollercoaster won’t slow down until the housing market reaches rock bottom—and we aren't there yet. Until then, keep your seatbelt fastened…

 

Comment below... Is the government doing enough? Too much? Are you worried about your finances?

The lipstick factor

In a week where headlines included more happenings in Russia, a potenially ill Kim Jong-il in North Korea, the government rescue of Fannie and Freddie, the teetering health of one of the nation’s most elite investment banks—Lehman Brothers—and an alleged sex and drug scandal at the Interior Department, who knew that the main headline-grabbing moments of the week would boil down to lipstick.

 

Folks, the campaign has entered The Twilight Zone.

 

Love her or hate her, the Alaska governor Sarah Palin is undoubtedly having an impact on the campaign, which is unusual for vice-presidential candidates.

 

In perhaps the most startling news, polls showed Palin stealing more than just the spotlight from the Democrats. She is also apparently swinging voters—white female voters in particular—to John McCain’s side.

 

The women’s shift

A Washington Post/ABC News poll certainly made the rounds this week, showing McCain with a 12-point lead over Barack Obama among white women. That same poll showed Obama in the lead of that group by eight points in late August. In the overall race, most polls show McCain and Obama in a statistical dead heat.

 

It’s been just over a week since Palin came out swinging in her first major address to the nation at the Republican National Convention, and her speech seemed to signal a new phase of the campaign. The tenor of the race is hotter, ads are more pointed, the rhetoric more strident. On Wednesday day-to-day campaigning descended into the absurd, with whole news cycles consumed with manufactured scandals over “lipstick” comments.

 

And one more thing seems clear. Even more than in the past, the 2008 presidential campaign is all about personality. As a top McCain adviser said: “This election is not about issues. This election is about a composite view of what people take away from these candidates.”

 

Sub-plots and questions

Much has been made about Palin and her ability to rally evangelical Christian voters. To be sure, leaders of the religious right, who had previously rejected McCain, are now on board. But it is hard to determine the overall impact on the race, because defining Evangelical voters is difficult and the group is not easily pigeon-holed. However, it seems clear that McCain will need religious voters to win in November. In 2004, people who attended religious services every week were 41% of the electorate, and 61% of them voted for George W. Bush.

 

The big picture

With Palin’s presence in the race, two huge questions loom: where is Hillary Clinton and what are her supporters going to do? Hillary has so far been unwilling to fire away at the Alaska governor, who has adopted Clinton’s “18 million cracks in the glass ceiling” mantra. And although the two women are diametrically opposed on the policy front, it seems as if Palin is indeed peeling off some jaded Hillary supporters from the Democrats. Stay tuned, this race just got very, very interesting…