September 29, 2008
-- by Dave Johnson
OK, the problem is that there is "toxic debt" out there and no one knows who will be affected by it. The toxic debt consists of "packages" of mortgages or other debt bundled up together. So imagine buying a package of 500 mortgages. What you now own is this obligation on the part of the mortgage holders to pay you a certain amount each month for the next 30 years (or until the mortgage is paid off.) If ALL the mortgage holders continue to make their payments, it is easy to know what your monthly revenue is going to be. But when you just don't know how many people are going to stop paying, it is nearly impossible to know what this package is worth.
And that is what is causing the problem. No one knows what the revenue from these things will be, so no one knows if they themselves can make their own payments and certainly doesn't know if others can pay them. And since everyone owes everyone else so much money from so many loans, no one knows who will be paying and who won't and therefore who will go out of business or not.
And that means that you can't trust ANYone to make their payments, because the people who pay the people who pay the people who pay them... might not be able to pay. Figuring out all those relationships is called "unwinding" it. THAT is what the bailout was about -- buying that "toxic debt" so companies could say that they are free of it and still in business (or not) and therefore get or give loans (or not). That lets the situation unwind.
The root of it is the housing bubble. And the root of that was a credit bubble -- too much credit. And that CAN'T be solved. Because NO ONE should ever have bought a house for so much money, or taken out second mortgages to buy cars and stuff. And it is done so it is too late really to do anything there. Like the answer to Iraq: don't invade Iraq. Now it's too late to solve it.
The problem though is what happens to businesses that ARE doing OK, but can't get the money they need, because the whole banking system has f'ed itself up? (Why would a sound company need money? Well, when you sell something you don't usually get paid for a while. And if you are owed ten million next Tuesday and have a payroll to make tomorrow, you have to borrow a bit.)
Even sound banks can't lend because they need to keep a certain amount in reserve and have loaned out the limit of what they can loan. The Fed has been propping that up.
The Bush plan was basically to just give money to the firms that might loan them money, so they could make the loan, by buying toxic debt from them without really caring what it turned out to be worth. It is an OK idea, IF the public is protected and the process is transparent. But the Republicans would have none of that.
This bailout can be salvaged IF they really do stop executives from being paid ridiculous amounts across the board, really do get real equity in the firms so that the public gains if those firms gain from this, really do get (fair) deals in bankruptcy court for some of the holders of those mortgages so they can pay, and really do tax Wall Street firms and transaction enough to recover the money involved. That is a start and should be done right away, even though it doesn't address root causes.
But like I said, Republicans are not going to go for that and we have to wait until Bush is gone.
One solution might be to set up new banks, from scratch. But that takes a bit of time. Another might be to set up what I call a Red Flag/Green Flag system so companies that do not hold toxic debt themselves get a green flag, and then you can visualize the networks of debt that do NOT have toxic debt in the chain...
Posted by Dave Johnson at September 29, 2008 11:55 AM
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Posted by: dennis at September 30, 2008 12:30 AM
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