Monday, 29 September 2008

If the US Government Were Just Some Guy

With the heady numbers thrown around when discussing the Wall Street bailout, it helps to put these things in perspective. If the U.S. Government were just some guy managing his money, how would that look?

If America were a guy earning $50,000 a year, he would also have a debt of $19,000 (with payments of less than $900 annually).

All the 2008 buyouts would cost $5,600. Of this, only $3,170 is distributed; the rest is held as guarantees for corporate loans. Most of the $5,600 will be back in government coffers within ten years.

In other 2008 spending, the Iraq and Afghan wars together cost $655 (a total of $2,780 since 2001); the Bush tax cuts and stimulus package cost $590; the food-stamps programmes cost $137; and children's health insurance was given $25.

The deficit was $1,435.

The current crisis was caused largely by the belief that good times continue forever. People who should never have been given loans were lent huge amounts of money because of practices in place: banks sold their risk to companies like Lehman Bros. who sold it to the market; the banks took commissions on the loans they made; and market investors had no idea how shaky their securities purchases were. Mortgage borrowers speculated wildly, buying houses before they were completed, selling them without ever living in them, and pocketing the profit while ignoring the possibility of the property falling in value. Eventually there were too many houses, prices fell, people got stuck with houses they couldn't sell (and therefore mortgages they couldn't pay), they defaulted, and banks, Lehman Bros, and the market got stuck with the cheque.

America's wealth gains in the last twenty years have come largely from no longer making products, but juggling money. Flipping currency between loans on factories makes more money, faster, than owning factories. Unfortunately it also means you're competing with companies who take on more risk than you, for greater profits. So you take greater chances with more money, and more loans, and higher throughput. But when you start getting into trouble, investors trust you for shorter periods of time with their money. Lehman Bros. got a little wobbly, investors started investing by the week instead of by the month, the transaction costs massively increased, profits nosedived, credit ratings fell, investors backed out, and suddenly the biggest bankruptcy in history appears from nowhere.

$600b is six times larger than the previous largest bankruptcy, Worldcom. Because so much money flows through Lehmann Bros, letting it fail would heavily reduce liquidity in the market (the money-go-round would slow down). In a finance-centred economy like America, this would cause the current recession to deepen. People who deserved loans would have to pay more to get them. Wages increases and new job creation would slow. So the government believes the best way to prevent this is to bail out financial institutions. They are too big to fail.
(And don't get me started on Fannie Mae or Freddie Mac.)

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