The word bailout is being used more than the folks at Merriam-Webster ever could have imagined. Yet, bailout is the wrong term to characterize the rescue plan the Federal Reserve and the Treasury presented to Congress. Our leaders have done a poor job explaining why.
At present, the U.S. financial system is in cardiac arrest, and this plan is the defibrillator designed to jolt the system back to life. The crux of the problem is that banks and other financial firms are holding securities for which there is uncertain value and no buyer. The uncertainty and inability of institutions to sell those distressed securities has brought the flow of money-the lifeblood of our economic system-to a halt. Banks have stopped lending to one another, which in turn impedes funding to companies, and the whole system seizes up. The result is a lack of confidence in our financial institutions, which may cause defaults to cascade further.
The stock market is a sideshow in the credit crisis theater. The real problem can be seen in the commercial paper market, abnormally high global lending rates between banks, and a money market fund that “broke the buck.”
Warren Buffett has described the scenario as an economic Pearl Harbor. As the crisis has spread, regulators have dealt with failing institutions one at a time. The rescue plan-which Congress appeared on the verge of approving at IBJ’s deadline-goes at the problem in a substantial way, in an effort to dislodge the logjam in the credit market. Let’s hope our legislators understand the gravity of the moment.
Here is the salient point that our leaders have failed to get across to the public. The $700 billion (and it may end up being a lot more) is not being “spent”-it is being invested. Granted, the funds will be invested in distressed securities-namely subprime mortgages. But the Treasury will end up owning assets that, if purchased properly, will likely be sold later for profit. The Treasury needs to buy these securities at current market prices, which are at discounted levels to the value that should be realized upon sale-given time and a better economic environment.
Wall Street institutions selling at these distressed prices are not being “bailed out.” They still will feel plenty of pain and, besides, we can deal with the miscreants later. But we don’t have time to dillydally. Failure to promptly act on this plan will severely infect the broader economy. When you have companies like Duke Energy drawing down $1 billion on a credit line, just because they are afraid they may not have access to cash to fund their daily operations-like making payroll-the situation is dire.
It is not a perfect plan, there are bound to be errors, and changes will be made as the plan is implemented, but it is the best course of action we have to attack the problem right now. Buffett has suggested that the Treasury might earn 15 percent on these investments.
The patient is critical, but with swift action, our financial system eventually will recover, as the U.S. possesses vast wealth. And while our economy may even worsen in the near term, investors who are putting money to work during this stretch likely will look back on this period, in five years or so, as a time where they bought low.
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or email@example.com.