This makes a lot more sense than a $700 billion bailout with $150 billion of pork attached to it, but let me start at the beginning.

Commercial paper is the term for low interest short term business loans (usually provided by financial institutions), that businesses need for day to day operations. By their very nature they’re considered to be very safe loans, so the rates are usually around 2%, and they are often bought by people looking for safe investments, like money market funds. When Lehman went bankrupt anyone who owned Lehman assets probably had to write them off (meaning they had to assume those assets had lost a lot of value). One of the money market funds that was forced to do this ended up writing down enough assets that it “broke the buck” – it lost investor’s money. This sent the market into a panic, and for a brief period of time, the commercial paper market ground to a halt. As commercial paper is necesarry for many business to function, this has disastrous effects on our economy. (As the politicians like to say, this is now where wall street is affecting main street). Currently commercial paper rates have quadrupled to around 8%, and most investors (like money market funds), are very wary of investing or holding onto longer term loans. (For the record, commercial paper is usually considered to be a loan of less than 1 year, and some countries have legislated that).

The initial proposal of buying 700 billion in bad assets from beleaguered banks was intended to have the effect of allowing the banks to unload their worthless assets (onto the taxpayers) so that they would all start trusting each other again. (Right now no one wants to trust anyone and therefore won’t lend out money). This would have had the ultimate effect of allowing lending to happen again, including the commercial paper market. However, it also would also have created an even larger federal bureaucracy, had taxpayers assuming all the risk, and had taxpayers subsidizing outlandish salaries by banking executives who have bankrupted their companies. (What’s with capping their salaries at 500K? If you want the taxpayers to save your incompetent rear you should have your income capped at the federal minimum wage – isn’t that supposedly enough to live on?)

The current treasury plan would be much more targeted – it would be directly helping the commercial paper market only. (Although indirectly everything affects everything of course). It wouldn’t be throwing hundreds of billions at large financial companies that made stupid decisions, and it would be helping main street directly rather than only helping them indirectly as a function of helping wall street. (Sorry, couldn’t resist). The large financial companies got themselves into this mess, and they should reap what they sow. They understand risk (or at least they should), and if they handled it incorrectly that’s their problem. In a capitalist economy bad ideas must fail. It will create a vacuum which other entities (perhaps new entities) can fill which ultimately drives innovation and creates a more robust financial system. If we can find a way to keep the rest of the economy afloat while they sink, so much the better.

This entry was posted on Tuesday, October 7th, 2008 at 10:21 am by Ari and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.