Entries for September 2008

Would the free market do it better?

That's one big sticking point for legislators opposed to a huge bailout bill to get the financial system back on track. Before the failure of President Bush's first $700 bailout bill on Monday, a memo urged 100 or so conservative Republicans to call for a "free-market alternative to the Treasury Department's proposal." Republican Rep. Mike Pence of Indiana, who voted against the bill, explains on his website that "renewing our belief in the power of the free market must be our guide" to a better solution.

Free markets sure sound good—after all, what's not to like, if they're "free"? But the pure and airy version of free markets that keeps showing up in speeches doesn't really resemble the way free markets work in reality. A few of the prevailing myths about free markets:

OK, so that didn't work.

After a bunch of all-nighters in Washington and some premature back-slapping, we're right back where we were a couple of weeks ago, after Lehman Brothers declared bankruptcy and the government lent AIG $85 billion. There's no one-size-fits-all bailout plan, after all. That $700 billion in taxpayer money remains under lock and key. Glum investors are now the ones bailing out, fleeing stocks and bonds and seeking safer ground.

But there are still some levers the government can pull. Working through the mess just won't be as orderly or predictable as it would if there were a single plan and a big pot of money. Here's what's likely to happen next:

Prepare to be disappointed: The Bailout of the Century will probably do little to make life better anytime soon for the taxpayers footing the mammoth bill.

The Emergency Economic Stabilization Act of 2008 may help avert the unspecified economic disaster that Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke keep hinting at. But for most of us, it's hard to fathom this freakish financial monster lurking in the darkness, unseen by anybody except Paulson and Bernanke. Instead, we cling to quaint notions, like the idea that for $700 billion in taxpayer commitments, we ought to get something tangible in return.

How many zeroes is that again?

It's getting hard to comprehend just how much money it will take to rescue ailing financial firms and avert the economic disaster President Bush predicts if a bailout doesn't materialize. All told, the proposed $700 billion bailout package, plus the cost of rescues for Bear Stearns, Fannie Mae, Freddie Mac, AIG, and the three Detroit auto companies, exceeds $1 trillion. How much is that, exactly? Test your mastery of exorbitant figures with this quiz:

Megamillionaires don't usually mingle with pensioners. But like strangers in a jammed elevator, they're stuck with each other for awhile. Big problem. Because the two groups don't like each other at all.

That's why there's so much bile and controversy over the $700 billion Wall Street bailout plan that President Bush and his financial henchmen, Ben Bernanke and Henry Paulson, are trying to force through Congress. To work, the plan needs to salvage big financial firms at the heart of American capitalism, so they can keep providing the money that consumers need to buy homes, cars, and even food. But those firms tend to be run by Gucci-clad patricians whose salaries are hundreds of times higher than the people whose homes and cars they help finance.

In Washington these days, an 11-figure expenditure barely attracts notice.

With Congress preoccupied with the massive, $700 billion bailout plan for the financial industry, General Motors, Ford, and Chrysler have finally secured Part One of their own federal rescue plan. A bill set to be passed by Congress and signed by President Bush as early as this weekend—separate from the controversial Wall Street bailout plan—includes $25 billion in loans for the beleaguered Detroit automakers and several of their suppliers. "It seemed like a lot when we first started pushing this," says Democratic Sen. Debbie Stabenow of Michigan, one of the bill's sponsors. "Suddenly, it seems so small."

But please don't call it a "bailout"—Detroit is too proud for that. Exact details will come later, but the loans would probably amount to at least $5 billion for each of the Detroit 3, plus smaller amounts for suppliers. That would allow them to borrow money at interest rates as low as 4 percent—a steep discount compared with the double-digit rates they're paying now. Over several years, the automakers could save hundreds of millions in financing costs. Plus, they'll have five years before they have to start repaying the loans.

It's not just a Wall Street meltdown.

The startling headlines from New York and Washington mostly involve staggering financial titans like Goldman Sachs, Morgan Stanley, and AIG and government plans to stanch the bleeding in financial markets. But the shock waves from the financial meltdown reach into industries far removed from Manhattan money mavens and the government regulators on their tail. Industrial firms, retailers, and even utilities have watched their stock prices sink since the financial crisis mushroomed in mid-September, mostly on worries about the credit crunch and how it might metastasize into the broader economy.

Since Lehman Brothers declared bankruptcy on September 15, sending the markets into a tailspin, the S&P 500 stock index has plummeted and rebounded—twice. Overall, the S&P 500 is down about 3.5 percent from its closing price on September 12, Lehman's last trading day. But since then, more than 20 companies have fallen by 10 percent or more—and fewer than half of them are in the financial sector. Here are the companies whose stock has fallen the most during the crisis:

Why do we keep relearning the simplest rules in the world?

Buyer beware. Cut your losses. What goes up must come down. If it seems too good to be true, it probably is. No matter how complex the market meltdown of 2008 might seem, all of these simple aphorisms—clichés, really—directly apply.

Of course, in every financial free-for-all—whether it's the S&L crisis, the dot-com bust, the Enron fraud, or today's housing-related meltdown—the chicanery takes a different form. On Wall Street, they call that "innovation." But right now, innovations like credit-default swaps and mortgage-backed securities look more like old-fashioned pyramid schemes: I'll take your money, you take somebody else's, and eventually some guy neither of us knows (or the government) will get stuck holding the bag.

Fixing the profound, arcane problems on Wall Street makes Social Security reform or a tax-code overhaul look easy. No wonder John McCain and Barack Obama have been fulminating about the unfairness of it all—while sidestepping specific prescriptions. "They're treading very carefully because they don't want to take a position that turns out to be laughable," says economist James Barth of the Milken Institute.

But as the stock markets have tanked and the government has rescued huge, foundering companies like AIG, each candidate has started testing ideas for overhauling Wall Street. McCain, who said earlier this year, "I'm always for less regulation," has been more vague, consistent with his free-market leanings. Obama, ever the wonk, has outlined a six-point plan that includes some old ideas and some new ones. Here are the most prominent plans each candidate has outlined so far:

Even if you're not the panicky type, the chaos in the financial markets sure is unnerving. Household names are disappearing, central banks are doing extraordinary things, and suddenly no company or investment seems safe.

But take a deep breath. There are still some reasons to be reassured—if the doomsaying and hyperbole doesn't send you in search of a ledge. Here are some of the misconceptions making the market turmoil seem even worse than it is:

If anybody knows how much worse the meltdown of 2008 is likely to get, it's Treasury Secretary Henry Paulson. But he's not telling.

Paulson held a press conference in the midst of momentous developments involving Lehman Brothers, AIG, and Merrill Lynch to say everything would be OK. In a few years. If the market cooperates. And the government doesn't run out of money. And politicians don't make things worse. And oh, by the way, don't blame me.

In fact, if you read Paulson's words closely, he wasn't that reassuring at all. Here's what Paulson said, along with some guesses about what he might have said if the global financial markets weren't scrutinizing every syllable:

Funny thing about Wall Street: Good news and bad news are often the same thing.

For every seller there's a buyer, and when one person is losing money, somebody else is usually making it. Even the most dismal economic news can send markets higher, if it means the Fed will cut rates or some other relief is imminent.

The worst market plunge since the 9-11 attacks is hardly cause for relief, and the collapse of storied companies like Lehman Brothers and AIG makes it seem like any company could tumble. But there's some good news mixed in with all the gloom. You might need a microscope to see it, but it's worth taking a look:

Name a tax, and chances are either Barack Obama or John McCain wants to change it. Obama wants to cut income taxes on lower earners, raise taxes on others, and give Americans an energy rebate funded by a new windfall tax on oil companies. McCain wants to cut the corporate tax rate from 35 percent to 25 percent, and extend the 2001 Bush tax cuts, which lowered rates on higher earners and are set to expire in 2010.

Good or bad? For many Americans, it's hard to know what to think of these various proposals, since the U.S. tax structure is so arcane. Here's a quiz to test your tax IQ:

When there's a bear market, Wall Street investors go hunting for the elusive bottom—the point at which bad times stop and things turn around. Investors sniffing around the flailing Lehman Brothers seem to seeking a bottom, too. This time, they're testing whether the government has the stomach for one more big banking bailout.

The likely answer: No way. That's because Lehman's collapse seems much more contained than other bank meltdowns that threatened consumers directly. The Federal Reserve ponied up $29 billion this spring to help salvage a rump Bear Stearns because a run on the bank's arcane mortgage-backed securities could quickly have spread to other banks, paralyzing the housing market. The case for last week's announced rescue of Fannie Mae and Freddie Mac was even stronger: The two firms directly support nearly 75 percent of all mortgages being written today.

Want a federal bailout? Get in line.

Now that the Treasury Department has finally announced its rescue of mortgage giants Fannie Mae and Freddie Mac—at a cost of up to $100 billion each—isn't it time to start tallying up all this largesse? A hundred billion here, a hundred billion there, maybe it doesn't seem like much at first. But before you know it, you've drained the treasury of the world's richest country. And besides, more rescues seem to be coming. Here's a tally of the bailouts so far:

The stimulus package. Maximum taxpayer cost: $150 billion
What taxpayers got: Free money, up to $1,200 from the government per household, to spend as they wish. Early research shows most recipients have used the money to pay down debts or boost their savings. Good for them, but bad for the economy, which benefits most in the short-term from spending, not saving.