Monday, September 29, 2008

The 700 Billion dollar question

To the best of my knowledge, I am going to explain the current situation.

The stock market suddenly plunged at the gloomy prospect of the credit crunch bringing the entire US economy to a grinding halt. We see a lot of "greed" being quoted as the reason for this problem. I am not going to into the details of explaining the greed, but the big picture is that, someone started lending money to a class of people labeled "sub-prime market". And now, many of them are defaulting. Fannie Mae and Freddie Mac, two companies which sold mortgage backed securities. In lay man's these two companies offered "insurance" to the banks for each of the home loans. Now, when many people defaulted, Freddie Mac and Fannie Mae went belly up to begin with. Next in line are the other companies that invested in secondary mortgage market.

But, the government saved freddie mac and Fannie mae. An important point to note here is, these two organizations could have gone under, just like any other company, but the government saved to avoid a ripple effect through the mortage market. (please correct me if I am wrong here).

Soon after that, Lehman brothers filed for bankruptcy and followed by many financial institutions including Meryl Lynch, Morgan Stanley and WaMu. Now, I hear there is something the government can do, to solve a problem called credit crunch. The banks loan amongst themselves for their day-to-day activities and apparently, since everybody is cash strapped, no bank is willing to give money on credit. So, the government is going to infuse into the system a sum of 700B and buy the bad debt from some of these companies.

From what I understand "buying bad debt" means, the government pays these companies the full value for all these assets which are valued at possibly 1% of these 700B. The good thing is, the banks are now freed to continue with their business, though it is not the end of the story...

This bill was voted down today, and I was very surprised that it was the republicans who did that. The republicans cannot all be characterized by the absolute lack of insight of people like Sarah Palin (see below) and I agree with the decision of the congress today.

Why should the tax payers money be given to banks to bolster "investor confidence"? Do you know, that if the 700B was equally split among all US taxpayers, each person would get more than $2000. What I don't understand is, why should the government buy bad debt from the banks? Why not buy it from people? Lets say government wants to improve the economy and so it agrees to pay 1 year's mortgage for everyone in the United states, wouldn't that also solve the same problem? The difference in the second method is that, the people will get to have their homes too!! But in the current situation, the banks just get the money for free.

I recently heard that people in finance sector earn about $150K annually on salaries, and about $300K in bonuses every year. How come the money market has been rewarding the financial sector so generously whereas all other sectors are being skinned? Apart from this, I have another minor annoyance as well. Apparently, all hell does not break lose if nobody saves these companies. There are a number of banks that do not hold mortgage based assets, example Bank of America. The world's largest bank Citigroup has mortgage based assets but it is not shaken because of many reasons and some of which are attributed to their global presence and diversification. The companies which were solely dependent on the mortgage markets (especially the five Wall street banks) are the ones that are affected now, so even if there is no Fed money pumped, the US economy will not grind to a halt as some have started predicting.

I don't know what will happen next, but I can take a guess. The 700B bill will be reduced to around 500B or small enough to just get as many votes to get it passed in the congress.

So, what do you think about this 700B bill?



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