Bailout Bust
The bailout failed, and I’m not sure if that’s a good thing or a terrible thing. To be honest, nobody is sure. As I mentioned previously in my post about Thoughts on the Bailout, I hated this plan. It contained no new regulation, and there was nothing to prevent the Return of the Bubble (the Echo Bubble?).
That said, we need something. We need it now. Here’s what’s going to happen without a plan in place.
There are lots of ways for companies to finance projects, but the biggest two are debt and equity. Debt is just what it sounds like: a company takes out a loan and uses the cash to buy stuff. Equity means that a company sells shares and uses the cash to buy stuff. The problem is, without any kind of intervention, the debt option is essentially gone for all but those with the very best credit. Equity is also pretty tough to pull off because most companies are loath to sell shares in this market, especially if it means accepting a lousy valuation and taking unfavorable terms. Goldman Sachs just got equity financing from Warren Buffett, and he was able to get an insanely good deal. Quite a few companies won’t be able to get money for equity anyway, because nobody else can afford to buy their shares.
So what does this mean? We can expect rapid slowing of the economy and a long recession. Unemployment will jump, probably to double digits. Market returns will be abysmal. Retirement funds will shrink. Our position as a global economic leader will be in peril.
Why is that? Because there’s no money for new growth and development. Companies built on the principles of easy debt will be the worst off – and we’re not talking about shady subprime lenders here. Think of companies like Boeing: their airplanes cost millions of dollars to build, and then they’re sold to buyers like airlines and leasing companies. What powers these transactions? Debt. The buyers borrow money to buy the airplanes, and then repay their debt using cash they earn over time. Without debt, nobody can buy an airplane that costs $200 million up front.
The end result is that companies will need to finance their projects using other sources or accept incredibly challenging terms from lenders. They can spend their existing cash, although few companies have large enough cash piles to make that a viable reality for big projects. They can also seek private cash, but cash is pretty hard to find regardless of the source right now.
Hence, I find it frustrating when I read that this is all about rewarding dumb Wall Street fat cats with our hard earned tax dollars. Sure, without government intervention, those bankers will likely end up in the bread lines. But then again, so will you.
well written. Thanks stanton!
You might also touch upon the unfortunate timing of the crisis. If it weren’t for the upcoming election, I’m sure we’d have had a bailout. And if paulson had presented a plan with (at least the appearance of) consequences for businessleaders, the public might never have taken affront.
I think one less obvious lesson is that we need to think more about the dichotomy of representative vs. statesman.
Paulson botched this. He thinks too much like a banker CEO and not enough like a Treasury Secretary.
The thing is, I actually have faith in his ability to spend $700 billion wisely. He’s a smart guy and very good at getting deals that work. The fact that Goldman has survived this mess should be proof enough.
It’s just that after January 20, he’ll be out of a job. Maybe the next president will keep him and maybe not. But the likely case is that someone else will have a $700 billion blank check, and who knows what kind of deals they’ll get?
I attended this Jeffrey Immelt webcast and you could tell he’s been crucified for taking the Buffet funding.