Bail out policy proposal

Policy Proposal submitted by a student.

Our government has spent money bailing out banks and other big industries. We have done this to save our economy. Our economy is still shaking, and many more companies are asking for bailouts. My suggestion is that instead of bailing out big industries we should bail out the taxpayers. People are losing their jobs. They do not have enough money to make ends meet. Therefore they are cutting back on their expenditures. If the government would take the amount of money they would spend on a bailout and distribute it evenly to all taxpayers, then that would boost the economy and the companies would no longer need bailouts. This is something that has never been done on a large scale before in this country. Our leaders have always depended on the trickle-down effect before. Obviously this is not working. If the American consumer had a large sum of money then they would have the means to buy cars, to put in savings accounts, to pay their bills, or to even buy a house. This increase in revenue would create a demand, which would give people their jobs back. It is time for the government to give back to the constituents that voted for them.

Student's analysis of their proposal.

I chose to write the above proposal because it is one of the federal-level policies that I care about. Right now the economy is very vulnerable. I realize that the government will never bailout the Average Joe. They say that financial independence is the responsibility of every individual. Then they go and reward bad behavior. They give money to the people that are some of the reason why our economy is in shambles, and they leave them in charge with few stipulations.

I actually got this idea from an email I received around the first bailout. A guy had actually figured out how much each U.S. tax payer would receive if the government would give us the bailout instead. I cannot remember the amount, but I do remember thinking that with that amount of money I could pay off my house, buy a new house, and buy a different vehicle and still have some left over. The email was just a joke, but it makes sense. The economy is not going to get better until the middle and working classes have money to buy products. Until they do people will continue to lose their jobs because there is no demand for the products they are producing.

My response to my student:

There is something to this. The government can “invest” $700 billion in the banking and financial sector, and expect to lose perhaps half of that investment in the long-run, but in the mean time the banking system will be propped up so that it doesn't collapse. Or, that same money could be used for something else. For example, the United States could establish a public bank that would give refinancing to everyone who owed money on a property, with 50-year 3% mortgages. All the commercial banks would get rid of their “legacy assets” as everyone refinanced using this public bank. This would in essence be “giving” money to Americans (people who are paying 5% or 7% interest would be paying half as much in interest, and keeping the rest for themselves). It might drive some banks out of business, but other banks that are bring driven toward bankruptcy because so many of their loans have gone bad will be saved as the people who are defaulting will transfer their debt to this national public bank.

If you divide $700 billion by 305 million (approximately the population of American citizens) you get a figure of $2,395 per each American. That is unlikely to be enough to help very many Americans buy new cars or houses. If you use a figure of $1.1 Trillion you still only yield $3,600 per American.

The $1.1 trillion is going to the following things, according to ProPublica:
$247 billion for banks.
$100 billion for purchase of bad loans (“toxic assets” or “legacy assets”).
$70 billion to prevent AIG from going bankrupt.
$60 billion to keep Fannie and Freddie Mac running.
$50 billion to help prevent foreclosures.
$25 billion to help auto companies avoid (or prepare for) bankruptcy.
$79 billion for other things.
$470 billion ready for whatever.
And by the way, there is a $500 billion line of credit for the FDIC, which may draw upon that to take over some of the largest banks that may be going insolvent.

Now, I wonder what would happen if the government gave nothing to keep up the banks, did nothing to buy toxic assets, let AIG go bankrupt, let Fannie and Freddie Mac cease operations, let the auto companies go through bankruptcy, and passed on the cost savings from all that to taxpayers. That would give each of us $2,000, and families with four persons would have $8,000. On the other hand, such a policy would mean that probably AIG, Bank of America, Citigroup, J.P. Morgan Chase, Wells Fargo, General Motors, Goldman Sachs, Morgan Stanley, U.S. Bancorp, Chrysler, Capital One Financial Corp, and American Express would all go bankrupt, along with about 100 other banks and financial companies and industrial companies. That would be okay if there were some big and healthy banks or private equity funds somewhere on the planet who could buy them up when they went bankrupt. However, the banks in other parts of the world are also in very poor financial condition. With so many of the most important banks going out of business, many companies would have to pay on the credit default swaps (billions of dollars promised as insurance that the big firms wouldn't collapse, so that entities owed money by the big firms would cover their losses if those big firms went bankrupt). This would create a domino effect that would cause the failure of almost all the large banks on the planet. Every major equities market on the planet would crash. It's entirely plausible that the only large financial institutions left standing would be ones that had been taken over by governments and central bankers.

Since almost all large companies depend on these banks to provide short-term credit to help make payroll and so forth, there would be very serious problems at most major companies outside of the financial sector. Layoffs and bankruptcies would multiply. The unemployment rate could go from 8.5% to 28.5% in a few months, and the stock market and equity markets all across the globe would drop by 80% or more. Consumer demand would drop like a meteor crashing through the atmosphere.

Tax revenues would drop and state governments would need to cut spending by 30% or more, but because there would be such high unemployment, the demand for government services (especially unemployment relief) would be very high indeed.

But, at least every American would have $2,000 or $3,000.

I agree with you that it is aggravating to see our money to go pay off the problems of the financial sector. I’d like to see the government take over all the big companies and fire all the managers and administrators, and replace the speculative financial sector with some sort of super-powerful national public bank. But then, I like the idea of planned economies and public control of key sectors in the economy (in economics I like some aspects of socialism), so for me this would be quite acceptable. But, practically, it’s not going to happen. The bailout is the policy we’ll get. And we've got to push for the best bailout we can get. One that will save world capitalism without throwing the world into an economic free fall that would make the 1930s look prosperous. One where American taxpayers aren't entirely ruined. One where the financial sector is tamed and the people who run that sector are knocked down to a humble size.

Mortgage Lending and Borrower Education

My reaction is to the policy that we suggested in class. I think it would be wise for the lender to require consumer education. Too many people in our country feel that it is their right to own a home. This is not a right, but rather, a privilege. It is a privilege that should come with a wise, informed realization of what financial responsibility comes with owning a home. It is the purchaser’s responsibility to find out what type of mortgage he/she is applying for and what interest rates apply. It is the consumer’s right, however, to have adequate information regarding the reality of owning a home.

I fully believe that if we had a policy implemented to help consumers become aware of how loans work many people now would not be in the foreclosure state. Lenders, too, would be regulated with this policy. It would be interesting to see how many foreclosures could be prevented with regulated loan bail-outs for the banking community. It is the lender’s responsibility to think twice before approving an unrealistic loan to a consumer. I honestly think that in the end, this policy would benefit both consumers and lenders.

The policy you chose to evaluate was one that would mandate consumer education about loans and mortgages for anyone getting a loan. I am unable to see how the federal government can have any justification in the Constitution for mandating such training. If the home mortgage loan is in some way involved with federal home loan guarantees, then yes, requiring consumer education could be part of the strings attached to whatever federal backing is given to mortgage lenders. There could also be a stipulation that the government would only provide certain services for banks when those banks had all mortgage borrowers complete consumer credit education classes.

The Federal Reserve Banks (which aren’t really part of the government, although their governing board is appointed by the government) did in fact try to educate borrowers about home ownership. The Department of Housing and Urban Development also provided good educational materials about home ownership, and supported community development corporations in their efforts to educate low-income credit-worthy potential mortgage borrowers.

What we have here is an essential problem. You are correct that a borrower has a responsibility to become well-informed and self-educated about mortgage debt and how housing loans work (although why this isn’t taught in middle school math classes escapes me). You are also correct that borrowers had a duty to notice how credit-worthy their borrowers were. In the case of our current crisis, lenders were able to quickly sell their home loans to financial wizards who would aggregate the home loans and sell bundles of mortgages as home lending derivatives. Since very few Americans traditionally default on their home loans, these derivatives were considered quite safe. And, since most home loans have borrowers paying 5% to 7% interest, these derivatives could yield investors 4% to 5% annual returns quite safely. Also, there had been no sustained or significant drop in housing prices in recent history (in living memory of the young people who were making, selling, or buying these home-loan-backed derivatives).

In 2005-2006 housing prices stopped rising. In Florida, Arizona, and Nevada the prices started to decline rapidly. In 2006-2008 prices for homes declined all across the Atlantic and Pacific seaboards, as well as in some “hot” real estate markets inland. Many speculators, including common middle-class people, had been buying investment properties or flipping homes, and these people were left with homes that were dropping in value, and no there were no willing buyers. This acted as a sort of trigger, and some of the mortgage-backed securities no longer looked safe, but people in the investment community weren’t sure just how unsafe those derivatives were. Were they worthless, or worth 50%, or 90% of what people had thought they were? No one knew.

A general credit-bubble that had increased consumption and consumer demand began to deflate as housing prices fell, and demand declined, but production was initially high, leading to a glut of products, softer prices, and falling profits. This in turn forced companies out of business. Big companies shrank, closing offices or outlets where sales were especially low. The resulting increase in unemployed persons added to the numbers of the unemployed whose jobs depended upon the housing market. Those in home construction or the financial paper-shuffling associated with home buying-and-selling (bankers, loan officers, mortgage brokers, real estate agents, law offices specializing in home sales, etc.) lost income, and this further eroded demand and hit retail sales. Suppliers of materials for home construction or infrastructure development that had been built to accommodate housing booms in places like Florida, Arizona, and Nevada began to lose business, and lumber mills in Georgia, Oregon, and other places shut down, swelling the ranks of the unemployed.

The very rapidly increasing unemployment rate (unprecedented since the 1970s in the rapidity of its growth) caught many people unprepared. As demand slumped, whole industries began to fall apart, including auto manufacturing and sales, construction equipment manufacturing, luxury goods, furniture, travel, and high-end restaurants. More people lost jobs, and many of these people found that they had been living from paycheck to paycheck, and had not enough reserve savings to pay their mortgages on time. Worse, in many places people found that their debt on their homes was now far more than the homes were worth. In recent recessions a person who had been laid off could quickly sell their home to raise money to help them get through the tough time. Home prices were generally stable or increasing, so people could cash in their homes and move to a cheap apartment until a new job came along. Now, however, with people having no money to gain from selling their homes, that avenue of escape was closed off.

Although the media plays up the idea that there are irresponsible lenders and borrowers, and indeed there certainly are many of those, I suspect that the vast majority of the persons facing foreclosure are merely typical Americans who have lost jobs and are unable to find new ones, and are unable to make payments on their homes, and are unable to sell their homes because housing prices have taken them from having $160,000 debt on a $210,000 home to having that same debt on a home that is now valued at $140,000 (or some variation on this).

When median house prices rise to over four or five times the median household income in an area, how are you going to be able to sell those homes? Mortgage lenders had to adopt new standards and lend people more money in those areas where the housing markets would have priced typical middle-class people out of traditional systems of home lending. So, in California or Florida or Virginia banks might give a family with an income of $70,000 a loan for $240,000 when in the past they would have only wanted to give a loan for $160,000 to such a household. So long as the $280,000 home the family bought with that money was likely to continue growing in value and become worth $300,000 in a year or two, this seemed safe. But, now that the house is worth $210,000 rather than $280,000 or $300,000, and now that one of the two income-earners in the family is unemployed and the household income has dropped from $70,000 to $40,000, the situation has become horrible for everyone concerned.

I like the idea of giving people education about home loans, and I think that such policies might be helpful in reducing the really crazy kind of lending to unqualified people that took place. But, I think the bigger segment of the foreclosure crisis is based on the American tendency to live on credit, and save very little. People were told to buy the largest home they could afford because housing prices always go up and housing is a good investment. And in fact, many people made fortunes on the growing costs of homes, and this fact was widely publicized. Given that situation, how many Americans would save 10% of their income in case of a recession where they would lose their job? Where would they save that money, in a safe investment that gave 5% interest? That would seem like a stupid thing to do when one could use that money to buy a much nicer home and then make 8% or 10% interest on the appreciation of the home while in the mean time enjoying living in it. Or, one could invest in the stock market, which had 10-year average annual return rates of 10%-15% (because of the rapid growth in equity prices in the late 1990s and for a couple years between 2003-2006). Now the stock market has declined by over 40% in a year, and housing prices have dropped nationally by nearly 10% on average across the country, and by over 30% in some areas.

This problem isn’t really reducible to a case of greedy and irresponsible home mortgage borrowers. Yes, such people exist, and it’s fun to think of them getting punished for their greed and ignorance. That is one reason why I showed pictures of people’s belongings scattered on the lawns and sidewalks of their former homes as the law-enforcement people moved them out onto the street. And a policy to help ignorant people become more enlightened will help somewhat. But, you can’t hardly lay the blame for the 30-year credit bubble economy on the backs of the 2%-3% of home mortgage borrowers who bought more than they could afford with the “help” of usurious loans from unscrupulous lenders.

I blame the baby-boomers and my generation X cohorts for generally failing to read enough history to realize that capitalism is prone to cycles of boom and bust. We had parents or grandparents who lived through the Great Depression, and their stories were there for us to hear if we asked. And if we did ask, we might have reflected on what they told us and thought to save 10% or 15% of our incomes instead of spending 102% of our incomes and living well, but building up resulting debts on cars, homes, and credit-card purchases.