Sunday, October 26, 2008

The Bailout Failure: Econ 101

WE'VE MOVED! Democratic Convention Watch is now at

Before you ask: the reason this post is going up when it ostensibly has nothing to do with the 2008 elections is that it actually does. Back to that at the end of the post.

The idea of "the bailout" was to un-freeze the credit markets. We are part of a world economy which depends upon credit in lieu of cash, and no one is lending. A ramification of this you probably know about is car dealers.


The way a car dealer operates is to sell cars. VERY RARELY does someone come into a dealership, look around, decide that they want a car with certain options not available in the cars on the lot, give actual cash (in greenbacks or a check) to the dealer, resulting in the car dealer calling the manufacturer, ordering the car to spec, and then having the buyer pick it up in a few weeks.

Most people buy a car off the lot, and they either put down cash as a down payment, trade in their old car, or do a combination of both, and then finance the rest of the car. You know this, the likelihood is that you have bought a car at some point in your life. And if you've ever paid cash for a car, you know that the dealer tries to talk you out of it, they want to make the loan.

To keep those cars on the lot, the dealers pay what is known as floor-plan loans. That is, they borrow money to effectually lease the car from the manufacturer until it sells. Therefore, when you buy a car, you're paying for the car, and what's known as the "hold-back": money which covers the dealer's cost of holding on to that car. ("Hold-back" is a little more complicated than that, but this is the fundamental.)

So, if the dealers can't get floor loans, they can't operate. They can't get floor loans if they can't move enough cars, which most people can't buy if they cannot get car loans.

And if you think that means we've lost a car dealer, it's much bigger than that. When a car dealer closes, not only do those employees lose their jobs, but also the local businesses which rely on the dealership are hurt. Less advertising, parts, office supplies, plus things the employees buy in the neighborhood: lunch, coffee, things from local shops because it's easy to 'stop on the way home'. Finally, there is the tax loss to the local government in terms of property taxes, and the tax loss to the state in terms of payroll taxes and sales taxes. Not to mention the amount that needs to be paid out by the state in unemployment benefits.


The idea of the bailout was to unfreeze money, so, for example, people could get money to buy cars, and dealers could float their inventories with floor-plan loans.

As it turns out, not only was that not the intention of the banks receiving the money, it was never Hank Paulson's intent, either.

A New York Times reporter sat in on an internal JP Morgan Chase conference call.

Here was the question:

"Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?"
Here was the answer:
“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase. What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”
What does that mean?

No car loans.
No floor loans.
They’ll be using the money to buy other businesses, most likely weaker banks.

The article details that Paulson’s intention was NOT to force banks to make loans, unlike the British, who made unfreezing credit a mandatory requirement of receiving bailout money. Further, Paulson had made contingency plans to help the banks make acquisitions if the bailout failed, and neglected to tell Congress about it. Although nothing about Paulson really surprises me.


From the same Times article:
Late Thursday afternoon, I caught up with Senator Dodd, and asked him what he was going to do if the loan situation didn’t improve. “All I can tell you is that we are going to have the bankers up here, probably in another couple of weeks and we are going to have a very blunt conversation,” he replied.

He continued: “If it turns out that they are hoarding, you’ll have a revolution on your hands. People will be so livid and furious that their tax money is going to line their pockets instead of doing the right thing. There will be hell to pay.”

Let’s hope so.

It’s incredibly simple: who we, the people, put into office (at all levels) determines who they bring with them.