Commentary Archive:

The Big Bailout
Friday, September 19th, 2008

Wow - what a week on Wall Street.  You hear a lot of new questions aimed at "putting taxpayer money on the block"; what does all of this mean for the average American citizen?  How about for the average investor?  And what about the foreign investment that keeps our economy afloat?

The problem
All of the trust that a buyer could afford a loan was placed into the hands of the "sales person" (e.g. the broker or lender).  Investors assumed that funding (or buying) those loans was safe, because it's being backed by a piece of real estate.  Since the lender was assumed to have done his due-diligence, this should be a safe investment.  Well, the duty of lender due-diligence was placed in the hands, again, of the sales person, and then obviously ignored during any "audit" or safeguard-checks, or simply unaudited altogether, and passed along to the investors.

Adding to the safety of real estate, and the assumption of lender due-diligence, the investments were often insured.  Almost a no-lose situation for an investor!  In this mess, lender due-diligence was completely bypassed in many cases, so the safe-investment system was inherently broken, leading to a slew of out-of-luck investors and insurers with no capacity to follow-through.

The solution
As they say, hind-sight is always 20/20.  The solution to this whole mess "would have been" as simple as verifying someone can pay their loan.  If they can't, don't lend the money.  Fairly simple.  For some reason, 100% trust was placed in the hands of the original sales person; if it's signed, it's sold.  I can't say that I know anyone who would sell something to someone, knowing they won't get paid.  In the future, regulation should carefully focus on the main threat, which is to verify ability to pay before a loan is paid.  Audit loans before they're approved.

Why should the American taxpayers put their money up?
The Fed and world banks are doing us all a favor by absorbing this problem with their bailout plans, for several reasons.  Primarily, to promote liquidity (lending) which has funded our economy-growth over decades (and centuries), and secondarily, to stop the bleeding.

What's in it for me?
  • If you are a homeowner, your home values are better protected, since foreclosures, if rampant, are, at least, government-backed.  Additionally, after the wave is over, foreclosures will essentially become a rare occurrence, like they were prior to this run-up.
  • The lending mess will be less likely to occur again; lenders will end up being required to verify the ability of the borrower, and insuring institutions will be more likely to verify their ability to insure.  Further, investment banks will be more likely to validate the value of the investments they recommend to their clients.
  • If you are not a homeowner, you might have a great opportunity to get a house more easily if you do research on foreclosure purchases, since foreclosed properties are sold on-the-cheap.
  • If you are an investor, you should always understand your risk, and can be assured that this type of risk (real-estate-backed investment) will be more secure.
  • If you are a worker, the company who employs you has a greater likelihood of future growth, because banks will continue to have the ability to fund the investment required to grow our economy and businesses, rather than being cement-footed by their investment in bad loans.
  • If you are a business owner, banks will again become willing to fund your growth.

Why should I care about foreign investment?
As Americans, we are fortunate that foreign countries invest in us.  It's the same as someone trusting you enough to lend you money.  If foreigners trust the "average American" enough to lend them money, then we ensure the growth of business, innovation, and our debt-economy.  In this case, the entire world has been lending to us, and the Fed has stepped in and essentially told the world that we are "good on our word", and we do repay our debt.

Why is this a good investment for tax dollars?
Probably so!  Believe it or not, the Fed might be making a reasonable (maybe very good) investment of your money!  Since these securities are being purchased at, in some cases 30cents on the dollar, the total investment is essentially at a 70% discount of what previous investors "thought" this was worth.  Given that these items are backed by real property as collateral, and the fact that not everyone will default on their home loans, the Fed, in my opinion, is essentially "purchasing USA property" at a significant discount from actual worth.  Don't forget - lots of this debt is owned by foreign investment, so the Fed is essentially buying back much of our country, at a discount!

Thanks Fed!
Overall, we should thank the Fed for doing what they've been asked to do - protect our economy.  The root of the problem here is, hey - lenders - make sure the loans you make are good.  Unfortunately, they are no longer around to be held accountable for a "small" mistake that turned too quickly into a "big" mistake.