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This is Why Bushs 700 Billion Dollars Bailout Plan Will Fail

Ben Modo
 


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Not long ago, the President stood before the American People to make his case for the massive bailout plan that Congress is now working to approve. With the sincerity and the passion that characterize him, President Bush made it clear that “this time is an extraordinary period for America's economy". He then went on to explain why he is urging Congress to support his plan to rescue Wall Street.

According to the President, his bailout plan represents the best we can do to solve the financial crisis and stop the mortgage meltdown.

In his plan, the Federal Government would take over bad assets from Wall Street since these assets cannot be bought or sold. They cannot be sold because they cost essentially more than what they are worth.

In other words, when banks issued loans to homeowners with their homes as collateral, they also converted these loans into financial products called mortgage-backed securities. These mortgage-backed securities were then sold to other financial institutions, therefore allowing banks to get the funds they need to issue more loans. As long as this cycle was repeated, the financial market was moving well.

Then, homes’ values started to go down.

When homes’ values go down, they make mortgage-backed securities become less attractive. This is because the collateral against these mortgages is now worth less than what banks want to borrow or sale the securities for. Here resides the key to the financial crisis.

The President's plan is to buy those mortgage-backed securities to allow banks to have more money.

The theory behind this is that if banks have more money and less risky assets, they will be more willing to lend to credit-seekers.

The main limit with this approach is that while the bailout may in fact put more money in banks’ hands, homeowners will not see their problem solved. They will not be rescued.

Backers of the President's plan forget that we are in this crisis because homeowners defaulted. They defaulted because they could no more afford payments. At the same time, they could not refinance their mortgage to get better deals because their home was worth far less than what they owed. This created the feeling of insecurity that is now dragging our economy down. And there is even more. . .

Supposing that after taking over these bad assets Government allows homeowners to make lower and affordable monthly payments; the economy will still face at least one serious challenge:

Assets removed from the market by Government will still be worth less than their face value. The same will be applied to most of the other assets not necessarily concerned by this bailout plan.

As a consequence, most of the mortgage-backed securities remaining on Wall Street will be, in a certain way, less attractive.

Investors will then continue to prefer non mortgage-backed securities since they not only present prospects of better revenues; but they also provide the security that investors want. Examples of options with prospects of good revenues and security are commodities like crude oil. . .

And when that happens, our economy will collapse dramatically. This is because the housing market is at the heart of America's economy.

This is the reason why I think that the President's plan to bailout Wall Street is a very risky plan that will only delay the collapse of our economy.

I believe that what this economy needs is a more efficient plan capable of solving this financial crisis at the root.

I propose a Program that will reduce homeowners’ debt to 80% of their homes’ market value.

How will this work?

On behalf of homeowners, Government will pay all amounts needed to reduce homeowners’ debt to 80% of homes’ market value.

These loans will be issued against promissory notes signed by homeowners.

Rescued homeowners will be required to make relatively low minimum monthly payments.

In addition to this, Government will be allowed to deduct a percentage of homeowners’ Federal and State tax refunds (if available) to help reduce loan balance. Agency in charge of this program will report accounts to credit bureaus on a monthly basis.

The destiny of America's economy will be placed, once again, in the hands of those who are more able to make it work again: The American People.

Adopting this plan will do 3 things:

First, when Government pays back part of homeowners’ debt, Wall Street will eventually receive the funds that are so badly needed to continue fuelling our economy.

Second, homeowners’ debt will be reduced to 80% of their homes’ market value, therefore making them eligible, once again, to shop for better rates and affordable deals. Paying less for their homes will free some funds that can be used to purchase more goods.

Third, America's housing market will be back on track, again. The market will be ready for new buyers and sellers, therefore sealing the revival of our economy.

However, this plan can only produce its best results if Congress complements it with a strong regulation that keeps the market under control. Otherwise, greed will once again destroy us.

Ben Modo is an Accountant, a Management Professional and a Financial Consultant. He has earned degrees in Business and Public Administration and he is the author of many published articles in economics and politics. Ben Modo was born in Cameroon and is married to Lydia. Together, they have two children, Stan and Dave Modo. Ben and his family live in the Washington metropolitan area.

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