BAILING OUT

by

Published: September 29,2008

“A long and painful recession.”

Those were the most startling words uttered last Wednesday night by President Bush in his speech to the nation, in which he implored Congress to move swiftly and pass a proposed $700-billion, taxpayer-backed bailout of Wall Street. Failure to do so, he said, would lead to unprecedented economic failure.

Any Wall Street financial firms who face implosion can participate in the deal, with the government buying up devalued assets — mostly mortgage-backed securities — and holding the bag if the values do not rise and do not resell.

Republican presidential candidate John McCain called the crisis “historic” and requested that last Friday night’s debate at Ole Miss between him and Democratic candidate Barack Obama be postponed until a deal is struck. The debate was moving forward as scheduled Thursday morning. Each man traveled to the White House Thursday to work on the details of the bailout package.

Selling — and begging, too

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke spent most of last week selling the package and begging lawmakers to pass it quickly. They echoed Bush’s warning that something had to be done or the U.S. credit market will virtually evaporate. Their initial overtures were met with a cool reception from both parties. An agreement Wednesday to limit the pay of executives whose banks participate in the bailout seemed to grease the wheels and reinvigorate negotiations.

Psychological impact

“From a market psychology point of view, I do agree that there is a great sense of urgency to implement a bailout to calm the fears of the capital markets and all of our investors — domestic and international,” said Dr. Lance Nail, dean and professor of finance at the University of Southern Mississippi’s college of business.

The White House had originally stood firm on its all-or-nothing position in negotiating the terms of the bailout; essentially, Paulson and Bernanke wanted what amounted to a blank check for the sum of $700 billion. The executive pay limit marked a softening of that stance. Another step should be to implement a deadline for selling the assets, Nail said.

“It would be nice to at least see a tentative timeline for the disposal of purchased mortgages so that Treasury is not perceived to be an open-ended provider of liquidity to the mortgage and credit markets,” he said, adding that the price tag of the proposal could either rise or fall, depending on how the market reacts.

“While this number seems reasonable, given the exposure of the government to the mortgage, banking and insurance markets there are certainly unpredictable and unforeseen negative impacts that could drive the cost of the bailout above this number,” Nail said. “If the government overvalues the mortgages they are purchasing or if there is exposure to derivative instruments not accounted for in these purchases, then the numbers would definitely climb. One thing to remember is that the wording of the bailout proposal states that the maximum amount of purchased mortgage-related assets outstanding at any time is $700 billion — not the cumulative amount of mortgage products that Treasury can purchase. So, by selling off previously purchased mortgage products Treasury can purchase more in the same value. So, the $700 billion is a moving cap — not a total cap. Of course, that also means that the cost to taxpayers won’t be $700 billion unless the mortgage products purchased by Treasury are completely worthless, and that’s not likely.”

‘Toxic assets’

At the monthly meeting of the Mississippi Economic Forum last week, the head of the non-partisan economic policy group the Concord Coalition referred to mortgage-backed securities as “toxic assets” whose value would be hard to determine on the open market.

“Any entity can get overleveraged by being totally dependent on debt,” said Robert Bixby. “That it’s taxpayer dollars (behind the bailout) is an important part of this.”

First District Congressman Travis Childers, a Democrat, said in a letter to House Speaker Nancy Pelosi (D-Calif.) that Congress should stay in session until a deal is struck. In a subsequent statement, Childers said that deal should not include a golden parachute for executives whose institutions’ failures led to the bailout.

“I stand adamantly opposed to any legislation that would reward investment banks for their gross mismanagement of our markets while the middle-class has been left to pick up the pieces.”

When and if a deal is made — lawmakers seemed confident Thursday that one is imminent — there will be a significant debt burden on future taxpayers due to poor financial decisions they had no part in making, the Concord Coalition’s Bixby said.

“This is not just a numbers issue,” Bixby said. “This is a moral issue. If you’re going to dump a huge debt on future generations, what does that say about us? One of the problems is, it can get people thinking that if there’s $700 billion around for this, what happens when there’s another issue? It’s a corrosive effect. It should be a shock and a wake-up call. The repercussions are going to be felt for a very long time, and people are eventually going to be very angry.”

Contact MBJ staff writer Clay Chandler at clay.chandler@ msbusiness.com .

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