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Bailout Passes in the Senate

On Monday afternoon, the proposed $700 billion bailous bill was defeated in the House of Representatives 207-226. Not surprisingly, it was quickly tried again, this time on Wednesday night in the Senate. There, a modified version passed by nearly 50 votes. The House will be voting on the new version later this week, probably on Friday after they’ve had a chance to look over it.

Here’s an overview of how what the Senate passed is similar to and different from what the House rejected. I’m basing my information on Money’s coverage of the bailout

Similarities Between Senate Bailout and House Bailout

It’s still based on the Treasury’s proposal to buy troubled assets from financial institutions. Most of these assets would be mortgages, mortgage-backed securities, etc. $250 billion would be immediately made available for purchasing assets, leading up to $700 billion total.

[One pauses to ask “Where are they getting this $250 billion?”]

Apparently the president would be required to propose a bill which would require the financial industry to reimburse taxpayers for the program’s net losses after 5 years. And in return for buying their assets, the Treasury would get “ownership stakes” in the companies.

[So is that where the money is coming from? Will this cause another crisis in 5 years?]

The Treasury will set up an insurance program which will guarantee the companies’ troubled assets purchased before March 14, 2008. It will be funded with risk-based premiums which the industry will pay.

[Wondering how an industry pays premiums. Does that mean the companies whose assets are being guaranteed? I’m also curious about the March 14th cutoff…I’ll have to look into that. It seems like this is the alternative to selling to the Treasury, you can buy Treasury insurance.]

Companies selling assets to or buying insurance from the Treasury will have curbs placed on executive pay. In particular, bonuses or incentives paid to senior executive officer based on meeting targets would have to be repaid if the earnings/profit statements were falsified or otherwise inaccurate.

[I think shareholders should have been doing this for a long time. Executives should have high salaries, but not if they crash and burn the company. If I completely screwed up at a job, you can bet that I wouldn’t get to leave with a multi-million $$ bonus.]

This bill will also set up two oversight committies. There will be a Financial Stability Board with the chairpeople, directors, and secretaries (the appointed kind) of the Federal Reserve, the SEC, the Federal Home Finance Agency [hadn’t heard of that], HUD and the Treasury. It’ll report to a congressional oversight panel with 5 members appointed by House and Senate leadership.

[Oversight is better than no oversight. If there weren’t some sort of oversight provision, I’d be concerned. As it is, I’m not greatly reassured by its existence either.]

Differences Between the Senate Bailout and House Bailout

The Senate version will temporarily raise the FDIC insurance cap from $100,000 to $250,000. The agency will borrow money from the Treasury to cover any losses. This would mean that, temporarily, you could have up to $250,000 per person with a single bank. But I wouldn’t bank on it (if you even have $250,000 in cash to put in a bank) because it’s only temporary. Probably.

[Wouldn’t it be great if the Treasury had a surplus instead of a deficit? Then borrowing money from the Treasury would mean something.]

The bill would also extend renewable energy tax breaks for individuals and businesses and continue other expiring tax breaks including R&D development for businesses and deducting state and local taxes from our federal returns. Also, this will mean another year without the Alternative Minimum Tax, which was a hot topic in the blogosphere earlier this year.

[I guess this is meant to get more people behind the bill because people want relief anywhere they (we) can get it. As always, this comes down to the question of whether higher or lower taxes are better for the country and the economy. Not even going to touch this with a snide remark…it’s more than I want to get into right now.]

What Does This Mean?

Nothing is set in stone yet. If you’ve watched Schoolhouse Rock, you know that bills get bumped around for a while. But it’s possible that this one will go through pretty quickly. To paraphrase Senator Obama, they could probably figure out a much better bill if given time, but the fear is that the economy won’t last that long.

If it passes, I can’t tell you what the result will be. I’m not an economist and I’m not even convinced that most economists know. One of my closest friends in college majored in economics and he said it was no more a science than sociology or psychology. Some things they’ve got right, a lot of it is informed guessing.

What I Can Tell You

What I can tell you is that whether or not it passes, whether or not the economy collapses, the groundwork of personal finance will essentially be the same. Spend less than you earn if at all possible. Earn more than you spend if at all possible. Put something away for the future. Get rid of debt, particularly debt that carries high interest.

These principles held true in the Great Depression, they held true in the tech bubble and in the housing bubble and in decent-but-not-spectacular periods. Part of what brings us to today is people NOT following these—people buying more house than they could afford, people borrowing against their equity, people generally spending more than they earned. And businesses and “experts” who had no concern for the welfare of their customers or the overall health of the economy but encouraged these people and used their status as bankers and loan trustees and the like to encourage peoples’ improper financial habits.

Good financial habits, even in bad times, will still lead to relative financial health. But bad financial habits, even in prosperous times, will ultimately bring about personal and societal poverty.


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Down Under Currencies Drop on Global Economics : Experiences of a Forex Trader
October 2, 2008 at 9:49 am
Stock Market News: Senate Bailout Bill Can't Save Stocks - Money & Investing - Banks.com
October 2, 2008 at 11:57 am

{ 6 comments… read them below or add one }

Aryn October 2, 2008 at 12:59 pm

You know, it seems like you, me, and ever PF blogger we know is saying we need to get back to fundamentals. Are we just preaching to the choir here?

What we need is for the media to stop announcing the sky is, has, and will continue to fall if Congress doesn’t act, and start encouraging people to be sensible about money again!

Dad October 2, 2008 at 11:39 pm

There is a lot of debate on this bill. I’ve probably read most varieties of opinions and I’m not sure anyone really knows.

But your last paragraph on good financial habits and bad financial habits is as always so true. People with the bad habits were in trouble even when the economy was soaring. The number of personal bankrupcies long before the bubble burst were all too high.

May be as Aryn said above, you are preaching to the choir, but keep preaching. We all need the encouragement and reminder of why we are here and from time to time some desperate new person will happen upon one of the these blogs and learn how to get financially health again.

Andrew Stevens October 3, 2008 at 4:38 am

One pauses to ask “Where are they getting this $250 billion?”

That’s an excellent question, actually, given the crisis in the credit markets. Obviously, they’re borrowing it. That’s why the United States federal government is in a unique position to act to unfreeze credit markets. U.S. Treasuries are the only bonds people and banks are still anxious to buy. It is ironic that the United States federal government has the lowest net worth of any entity on the face of the planet, but it’s also the only entity with the credit to resolve this crisis.

So is that where the money is coming from? Will this cause another crisis in 5 years?

Well, no, though it might be how the loans the U.S. government is taking out get paid back. As for whether it will cause another crisis in 5 years, there’s no earthly reason why it should. The equity warrants the Treasury will be acquiring will also help to recapitalize the companies and the equity can be sold later at the Treasury’s leisure, perhaps making a profit on the deal.

Wondering how an industry pays premiums. Does that mean the companies whose assets are being guaranteed?

Yes, it does. (They’re setting it up like FDIC insurance. Banks are required to pay premiums to the FDIC to insure the accounts of their depositors. When the FDIC pays out depositors of a failed bank, taxpayer money is usually not involved, barring an extraordinary crisis such as the S&L crisis of the ’80s.) I’m not a big fan of this provision since this reduces the capital of the institutions right away, which rather defeats part of the point of this bill.

I’m also curious about the March 14th cutoff…I’ll have to look into that. It seems like this is the alternative to selling to the Treasury, you can buy Treasury insurance.

March 14th was the date Bear Stearns failed. The Treasury probably has the theory that anyone who picked up the assets after that date did so in order to speculate that they’d improve in value. So the Treasury believes that they should profit or lose on that transaction on their own lookout.

I think shareholders should have been doing this for a long time. Executives should have high salaries, but not if they crash and burn the company. If I completely screwed up at a job, you can bet that I wouldn’t get to leave with a multi-million $$ bonus.

There are good and bad reasons for executives to be so highly paid. Really good executives can be worth far more to their firms than they are compensated. (An extreme example: Warren Buffet only gets $100,000 a year in salary. But even CEOs who pull down $3,000,000 can easily be worth ten times that if he’s really good at his job.) Many CEOs who make a ton of money due so because the company has seriously appreciated in value during their tenure, making their stock options (which are used for compensation in order to closely align the executives’ interests with the stockholders’) very valuable. Had the stock declined, they would have only made their base salary (which, granted, is often rather high as well). There are various reasons why stockholders don’t heavily police executive compensation. More and more, the stockholders are big institutional investors (mutual funds) who just don’t see that as part of their job. Moreover, there’s a free rider problem. The person who takes the time and trouble to police executives’ actions has to invest a lot of time in the effort, yet he doesn’t benefit any more than anyone else. There are fewer problems in companies which have more concentrated ownership. In any event, if executives are too highly paid, it’s the stockholders’ pockets it’s coming out of. If they don’t care, I don’t see why anyone else should.

As for CEOs occasionally getting paid millions of dollars after they screw up, a bad CEO can cost a big company billions of dollars. It’s often cheaper just to pay him a relatively small amount of money to get rid of him. It should be stated that all of the CEOs who got ousted in these latest bailouts have received virtually nothing. The CEOs of Bear, Lehman, AIG, Fannie Mae, Freddie Mac, etc. were all thrown out on their ears.

Wouldn’t it be great if the Treasury had a surplus instead of a deficit? Then borrowing money from the Treasury would mean something.

The U.S. debt has not really been that big a deal, which is why the federal government’s credit rating is still the best in the world. However, it has accelerated massively just in the last month. It’s still very far from being a crisis. After World War II, the U.S. debt stood at 120% of GDP. Within 15 years, it was paid down to 60% of GDP. It stands right now at about 65% of GDP. That is the highest it’s been in about 50 years, but not a lot higher than it’s pretty much always been for the last 50 years. (Its lowest level in that time was during the Carter administration when it was about 35%.) I wouldn’t be too terribly concerned about the debt. For normal people, debt is a bad thing. But the United States federal government pays less interest than anyone else in the world; it’s not like they’re paying credit card interest rates. Having said that, it’s clearly a good idea to pay off some of the debt when times are fat. It would be a horrible idea to do so now.

One of my closest friends in college majored in economics and he said it was no more a science than sociology or psychology. Some things they’ve got right, a lot of it is informed guessing.

Well, it’s not an experimental science, certainly. It’s pretty difficult to run controlled experiments in macroeconomics. Still, it’s far more of a science than psychology or sociology, if only because there’s a lot more mathematical rigor involved (which you don’t really do a whole lot of as a mere undergraduate in the subject). The basic thrust of his comment isn’t wrong. There is a lot of informed guesswork, but that sure beats uninformed guesswork.

John Maszka October 6, 2008 at 5:10 pm

This bailout is just one more example of the indivisible handjob stroking irresponsible CEOs and CFOs with billions so that they can run the American economy even further into the ground. So much for Keynesian economics. If the goal is to stimulate the economy, why not give the money directly to the American taxpayers? We could do twice as much good for the economy by giving half as much money directly to hardworking American taxpayers. A bird in the hand is worth two in the bush administration.

Andrew Stevens October 8, 2008 at 12:44 am

John, you’re not wrong that the “helicopter money” could just as easily be given to American citizens. However, there is no time for that. Frozen credit markets could cause a cascade of business failures before the money could be distributed. It’s one thing if businesses have to borrow short-term money at 12% instead of 6%. It’s another thing entirely when they can’t borrow money at all.

Andrew Stevens October 8, 2008 at 12:51 am

I should say, by the way, that I have no idea if Paulson’s plan will work, but I know a direct stimulus to taxpayers wouldn’t. It would take too long.

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