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Deal Or No Deal: What The Bailout Means To You

Following the $700 billion money trail

By Mark Huffman
ConsumerAffairs.com

September 25, 2008

Personal Finance • Economists' Panel Sees Prolonged Recession • Getting A Small Business Loan in Bad Economic Times • Jobless Rate Spikes in October • Monthly Job Cuts Hit Five-Year High • Business Economists See More Signs of Recession • What's Ahead For the Economy? • Consumer Confidence Plunges to Record Low • Bankers See Recovery in Second Half of 2009 • Autumn Has Long History as Financial Disaster Season • Finding a Job Takes Longer in Slow Economy • Baby Boomers Scramble to Reassess Future • What's Your Recession Game Plan? • Study Finds Racial Disparity in Retirement Savings • New York Threatens to Prosecute AIG for Fraud • Inflation Not a Factor in September • Retirement Postponed for More Americans • Economic Worry Supplants Terrorism Fear • Wall Street Leaders Missing In Action • Doctors Worry About These Stressful Times • Financial Meltdown Takes Toll on Consumer Confidence • Economic Turnaround Will Take Time • Retirement Plans Hammered in Credit Squeeze • Fed Takes Another Step to Bolster Credit Market • Economists Offer Plan for Stabilizing House Prices • House Passes Bailout Bill; Bush Signs Into Law • Senate Expected to Pass Bailout Bill • FDIC Seeks Increase in Deposit Coverage • Voter Anger Rattles Congress; Bailout Fails • Congress Agrees On Compromise Bailout Bill • Somber Washington Prepares for Bailout • Deal Or No Deal: What The Bailout Means To You • FDIC May Need Additional Funds if Banks Keep Failing • Which Type of Money Market Account Is Right for You? • How Does The Banking Crisis Affect You? • Lehman Files Largest Bankruptcy in U.S. History • Why Individual Investors Shouldn't Buy Individual Stocks • Bear Stearns to Pay $28 Million to FTC for Abusive Lending Practices • When Should You Sell Exchange Traded Funds? • Has the Bear Market Hit Bottom Yet? • How Do You Survive a Bear Market? --- • More Personal Finance News

The details are still being worked out, but it appears that Congress and the White House have worked out a tentative financial bailout plan.

While it may take several days for the intricacies of the plan to be revealed and fully digested, consumers might be asking what such a massive spend bill means to them.

For starters, the U.S. Government doesn't have a spare $700 billion lying around and therefore will have to borrow it. That's another way of saying government printing presses are about to go into action.

Beyond the incredible risk, there is other short-term downside for consumers. Borrowing this much money is likely to be inflationary. That makes the dollar worth less. Since oil is priced in dollars, we could see oil prices head up again, even if world-wide demand remains low. Other things would go up in price as well.

What exactly happens to the $700 billion? Under the plan drafted by Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke, a new federal entity would purchase mortgage-backed securities from troubled financial institutions. Right now these securities have no trading value because they might contain pieces of subprime mortgages that are in default, or may go into default.

If the government agrees to buy them, the financial institutions get them off their books, gets some needed cash, and can begin to do business again. At least, that's the plan.

But isn't this a bad deal for taxpayers? Many argue that it is, but it all depends on how much the government pays for these "toxic" securities. If it pays full price, then absolutely it's a terrible deal. But the idea is to offer pennies on the dollar, getting the securities at a steep discount.

It's important to understand that these securities aren't worthless – they just don't have a market value because, at the moment, no one will buy them. The securities are backed by real estate, which may be worth a lot less than it was a year or two ago, but at least has some value.

There is another advantage to the government owning these mortgages. As the owner, it will be in a better position to renegotiate terms to help people stay in their homes and avoid foreclosure. The way it is now, lenders have a harder time doing it--even if they wanted to-- because they only own pieces of the problem mortgages. One mortgage might be spread among a dozen or more securities.

Congressional Democrats this week pushed Paulson to include mortgage help for consumers in the package, and he indicated his willingness to accept that. It also appears likely that the rescue package will place limits on executive compensation for participating firms.

While much is left to be done, including the creation and administration of a complex new government entity, there are some who believe that taxpayers can actually profit from such a deal. Andy Kessler, a former hedge fund manager and author of the book, "How We Got Here," calls the deal "the mother of all trades."

Writing in the Wall Street Journal, Kessler says taxpayers stand to make as much as a $2.2 trillion profit once all the securities are bought and eventually liquidated.

That's best case of course, and experience shows its never wise to bank on the best case. Still, backers of the Paulson plan say to do nothing would begin the financial dominoes tumbling, and that they wouldn't stop on Wall Street, but spill over onto Main Street as well.

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