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The $700B Bailout Bill (Update8)

Update8: It’s done, both chambers have approved [3] the updated bailout bill that contains a ton of other stuff… House Republicans got what they wanted. Bush just signed it [4].

Update7: The Senate will vote today [5], after sundown in observance of Rosh Hashanah, on a tweaked version of the bailout bill that the House rejected on Monday. There are a couple changes to it, none of which really affect the terms of the bailout itself but could sweeten the pot for House Republicans:

Update6: The bill didn’t pass the House. [7] Back to the drawing table, lawmakers are working on a new bill [8].

Update5: The details of the agreed bailout bill [9] have been released and they are:

All that remains is the vote in both chambers and the President signing the bill. Whew.

Update4: A deal has been reached [10] and all that remains is to put it on paper. The plan, according to a release by Speaker Pelosi’s office, stated that the plan “gives taxpayers an ownership stake and profit-making opportunities with participating companies; puts taxpayers first in line to recover assets if a participating company fails; (and) guarantees taxpayers are repaid in full — if other protections have not actually produced a profit.”

The $700B would be broken up into three phases: $250B available immediately, $100B “upon report to Congress,” and the last $250B available upon Congressional action. There are additional details in the WSJ article.

Update3: It appears as though the once 3-page bailout bill has now gotten up to 102 pages [11] but progress is being made and now the ETA appears to be Sunday. I don’t know about you but for once I’m glad a bill swelled in size, the thought of $700B in spending passed in a mere three pages was a little disconcerting (not to mention there was no oversight!).

Update2: Uh oh, looks like there have been some problems [12]. From the front page of CNN: “Sen. Richard Shelby, ranking Republican on the Senate Banking Comittee, emerged from the White House to declare of the bailout plan: ‘It will not solve problems, it will create more problems.'” Yikes! But it sounds like only the House Republicans are having problems with it [13]

Update1: Reports are coming in that an agreement in principle has been reached. According to the Wall Street Journal [14], the $700B package would come in installments with $250B available immediately with $100B to follow as necessary. The balance would be doled out as needed and Congress can block it. Word is that executive pay for bailed out firms would be limited, the government would get a stake in the companies, and most other major issues are resolved.

Original: If you’ve been watching the news, you’ve probably heard of this massive $700B bailout bill that Henry Paulson, the White House, and Congress have been arguing over [15] for the last week. Republican presidential hopeful John McCain suspended his campaign yesterday [16] and threatened to cancel Friday’s debate unless a bailout bill agreement was reached. Both candidates will be heading to Washington today to get in the way and take photographs.

Last night, President Bush gave an address [17] in which he proposed “that the federal government reduce the risk posed by the troubled assets and supply urgently needed money so banks and other financial institutions can avoid collapse and resume lending.” and that “Our entire economy is in danger.”

My eyes have popped out of my head for the fourth time in two weeks at the numbers being thrown around… it’s like each bailout is trying to top the prior bailout. This time it’s seven hundred billion dollars.

What’s In The $700B Bailout Bill?

The Treasury wants the authority to buy up to $700 billion in “troubled assets.” In reality, the proposal wasn’t much more than that and took up a mere three pages. At first, that proposal included language that gave the Treasury complete authority with no oversight from anyone (for the first time in history, I’m happy Congress was designed to move “deliberately”). Fortunately that was scrapped and oversight was included in future versions. Here are other provisions the Democrat Congress wanted included:

As of this morning, they’d gotten close to reaching an agreement. This page will update as more details emerge.

Why Do We Need This?

Why is this bill necessary? Our financial system depends heavily on financial institutions being able to lend money to one to one another. When you deposit $100 into a savings account, the bank can lend 90% of it away to borrowers (car loans, mortgages), to other banks, and to the government (Treasuries). If they lend it to another bank, that bank can in turn lend around 90% of it and if it lends it to another bank, that bank can lend 90% of that. So your $100 turns into far more when it flies around in the economy and that has fueled our tremendous growth.

What role does bad mortgage debt play and why do we need a $700B+ package to buy up this bad debt? The simple explanation is that financial institutions no longer trust one another. Let’s say I lend you money and you put your house up as collateral. If you default, we could always sell your house and I can get some of my money back. If we’re suddenly in an economic environment where your house could be worth far less than what your appraisal says… I’m going to slow down and maybe not lend you as much money (or none at all). That’s kind of what’s going on now. With all the bad debt rolled up in good debt, financial institutions don’t trust one another and that’s why it could cripple our economy.

Why is it better to shift the debt off a company’s shoulders and put them on MY shoulders? That’s an excellent question and I don’t have a good answer for you. We will have to see how the plan goes forward to really know but I believe the reasoning is that the bad debt can improve in the long run, much like how housing prices will go up in the long run, and the U.S. Government can wait that long. Ultimately, the belief is that this bill will infuse life in the same financial markets that have fueled prosperity in the last few decades and I think that helps everyone (but we’ll have to see!).

This is similar to the logic behind the AIG bailout. AIG had its credit rating reduced, forcing it to raise collateral in a short period of time. The government swooped in to keep AIG solvent and took an 80% piece. From what I’ve read, AIG’s subsidiaries were all profitable, it was just a short term liquidity issue. Is that the whole story? Who knows, that’s just what I, and everyone else, read in the newspapers.

As news breaks, I’ll keep this post updated.