Bailing Out the Big Dogs
Americans have seen a lot of changes in their country in the past decade. There have been terrorist attacks, natural disasters, three wars that were started with no end in sight. We have high gas prices, an increase in pointless partisan bickering by both major political parties and a government that has become more oversized and bloated then ever before. Now, we have an economic crisis in the United States and the world which the American taxpayer is going to have to pay for.
How did this current crisis happen? Who is to blame?
The answer to both questions is Congress and notable Wall Street institutions like the now-defunct Lehman Brothers.
Congress' part in this crisis was nonpartisan; both Democrats and Republicans are to blame. It pressured institutions like Freddie Mac and Fannie Mae to insure mortgage loans to lower income people and to buy the loans from commercial banks like Washington Mutual and Wachovia. Congress' intention was to allow lower income families to afford a home for the first time.
According to the Wall Street Journal this resulted in many loans to people who could not afford to pay for them. Local commercial banks had nothing to lose because if the borrower defaulted on the loan government-sponsored institutions like Freddie Mac and Fannie Mae would buy the loans. This is the reason for the current collapse and government takeover.
Investment banks like Lehman Brothers, Morgan Stanley and Merrill Lynch were equally culpable as congress because they bought many of the same bad loans to package and sell to foreign institutions and governments. The result was that the crisis spread beyond the United States into other nations. When borrowers began to default on payments these investors quit buying what was essentially junk paper. This left these banks holding the bag and forced Lehman Brothers into bankruptcy. To avoid the same fate, Merrill Lynch sought a sweetheart buyout by Bank of America. Morgan Stanley is negotiating with the Japanese conglomerate, Mitsubishi UFJ Financial, to save itself from collapse.
Now Congress wants to clean up the mess with a $700 billion bailout. Moreover, congress wants it to come out the pockets of everyday hard working Americans who may have nothing to do with the mortgage and credit crisis.
The bailout will not only increase the budget deficit this fiscal year, but will increase the national debt. This could lead to massive deflation of the United States dollar like Germany had post World War I. Nevertheless, if congress does nothing, the outcome could be worse.
The collapse of the credit market on Wall Street has led to banks not loaning money to ordinary people for college, small businesses and many more everyday lending activities. All businesses throughout the United States, and even around the world, from large to small, have been affected by this crisis.
Congress's bailout is not a real solution but an attempt to inspire confidence in investors. This is important because banks are becoming insolvent like the 1929 disasters that lead to the Great Depression.
Will the bailout work?
The answer is no. World markets are panicked. Investors are selling off their assets to avoid losses. They are afraid of how things are today, tomorrow or the next day. Because of the panic the government's bailout is actually a very bad idea because it does not reassure investors of the market's strength. It instead makes investors see the market's weakness. Obviously when people see that the train that they are on is going to crash, they try getting off and not staying on it for the long haul. That is part of the current panic. People do not have any confidence in the market nor if or when it will recover from this crisis.
The other part is that people are afraid to trust banks because they simply do not know the financial state of their banks. A fine example is Washington Mutual, now J.P. Morgan Chase. Although it was heavily hit by the mortgage crisis which turned into the credit crisis, it may have been a salvageable institution. But, in the one month before its collapse, it lost between $15 and $16 billion in deposits. This caused Washington Mutual to become insolvent and led to federal government's auctioning the company to J.P. Morgan Chase for $1.9 billion, according to the Washington Post.
With banks failing and large Wall Street institutions collapsing, what the current market needs is confidence to be raised. The bailout was a nice try but, Wall Street really needs the private sector to raise confidence. When the government is involved, investors tend to see negative and not signs of a positive growth potential. The survival of Morgan Stanley and its deal with Mitsubishi UFJ Financial would be a big confidence builder to investors on Wall Street and the world. More transactions like the Morgan Stanley and Mitsubishi deal would bring back investors to the market and inspire confidence in the U.S. and world economy.