My 2 cents on the ‘Bailout’ or ‘Splurge’

Where to start? Yesterday we had the biggest point drop in the Dow Jones since 1987, triggered by a failed attempt by the US government to launch a rescue package to save the credit markets. But the package failed in the House of Representatives. How do you write a short post to sum up my point of view when many things are connected with each other? Let’s try.

First of all, I believe that until now the freezing of the credit markets has not been understood or felt by the population and law makers. It still seems to be very theoretical. The economy is not strong but right now it does not feel like we are in a bad recession. But things are changing:

Last week I got a letter from our bank regarding our home equity line. When we bought our house, this home equity line was ‘forced’ upon us even though we did not want or need it. The bank hoped to upsell, but we did not feel the urge to buy a new TV or car or else (I got a nice check books to pay for stuff with my home equity loan). Anyway, I guess many people use these lines of credits and live of them. Surprise: Now it is gone. The bank informed us that they deemed the value of our house to be too low to support the line and canceled it. If we received such a letter, I bet they were closing down all home equity lines in our area, state or even nation wide. These days banks are not so eager to give credit – cash is king.

This means the credit crunch has arrived – now it starts to get real for the individual consumer after 18 months. I read as well that last week American Express reduced the credit allowance of all its cards on average by 50%. The coming holiday season will be no fun for the retail sector.

But it makes sense: Savings rate have been negative in the US for many years. Why would you build a safety cushion for bad times, if you have $100.000 in credit lines you can always tap into? No more. As credit stops being available to consumers, they will have to cut down on spending even harder – not only have the stop to buy on credit, but they will try replace this safety cushion that is now gone by saving money.

This will kick off this recession people have been talking about. Consumers stop buying, companies stop selling, companies go broke, employees loose jobs and hence stop spending etc.

But not only that, the credit freeze impacts (and has been impacting for a while) businesses. Profitable companies that have financed investments with loans that might come up for renewals can suddenly not find anybody to renew the loan. This leads to bankruptcies, leading to people loosing jobs, reducing their spending etc.

Now: This ‘Bailout’ – who is it bailing out? Not the investment banker on Wall Street. They have been doing fine in the last years (and I am not going into the question who is responsible for all these complex credit products that blew up and lead to the credit freeze – not interesting right now where we are. This will have to wait for later). The ‘Bailout’ is paid by the consumer and eventually for the consumer. Because the average consumer is the person that will suffer from this if we go into full blown meltdown.

So Congress does not serve well its constituency by blocking a package that is aimed to get the credit markets that our economy / society is built on moving again. 5 weeks before elections, many representatives did not want to be seen as ‘bailing out’ the fat cats on Wall Street. So the problem is that the people that do not understand what caused the credit freeze (which I did not comment on in this post) do not understand what this bailout is for.

Having said that, the bail out plan was not perfect. But I agree with Paul Kedrosky: we do not have the time to come up with, discuss and mull about the best probable plan. We need ‘a’ plan. And leadership that can push this plan through.

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