Why the govn't does not invest 700B$ in education, heath care, alternate energy but bailout the banks instead?

Question

I mean the role of the banking system and the capital market is supposed to funnel capital sectors that are good investment. The recent banking crisis can be attributed to the failure of this system to allocate money to where is needed, but rather over allocated to an excess sector like housing. Bailout will violate the principle of free market but saving a system that made serious mistake. Why not the government take control with direct investment in education, health care, alternative energy to create jobs and economic activities instead of saving a failed banking system? Many countries after the WWII such as Japan has government controlled strategic investment and produce good economic results. Is bailout of the banks really a solution that make sense or just because the politics? can someone explain to me?

Answer 1

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The roll of the banking system to really to provide credit, not provide capital to fund sectors in the economy.

"An important part of the Federal Reserve's statutory mandate is promoting the availability of credit throughout the banking system."
http://www.federalreserve.gov/newsevents…

Banks loan money based on risk models. Clearly their models failed miserably. They over lent in the real estate market and assumed two things.

1. Real estate prices can never go down.
2. Interest rates can never go up.

The FED Funds rate went from 1.00% on 06-25-2003 to 5.25% 06-29-2006 - a 425% rate increase. This killed the real estate market.
http://www.federalreserve.gov/fomc/funds…

Anyone with adjustable rates were severely impacted. And millions got signature loans, leveraged phantom equity in their house and bought more real estate.

Thus I have to respectfully disagree with the statement that, "The recent banking crisis can be attributed to the failure of this system to allocate money to where is needed." That would not be the role of banks.

Banks PRIMARY business is lending in the area of home and commercial real estate. The stock market provides capital to new and expanding business that banks do not want to take such risk.

Yes, a bailout would violate the principles of a free market.

However, the risk to the US banking system and hence the US economy are a far greater risk. We, as consumers cannot afford to allow massive banks failures. The result could be huge unemployment 30%+, soaring inflation/ interest rates (25-30%+), and a plunge in the US Dollar, further escalating inflation (everything will get expensive fast). This would make The Depression look like an e-Ticket at Disneyland.

Taking government control over the entire economy would be called Socialism. We would be looking at income taxes like most socialist countries who pay ~50% on income taxes with no deductions no matter how much you make. Socialists’ counties also pay 40-50% in sales tax. That is why people don't drive luxury cars in mass in Europe, have big screen TV's, as they do in the USA. Europe also pays double what we pay for gas. It's the high EU socialistic taxes that everyone has to pay to live in socialists countries.

They also live what we would call apartments or very small housing in comparison. There are exceptions, but they are not common place like they are in the US.

Sure you get health care and education free, but it really isn't free, because Europeans pay for those social programs via higher taxes. That is why we left Great Britain 232 years ago. Why would we go back to that program?

The USA spends more on education than any country in the world. We have more government sponsored universities, state schools, junior colleges, and K-12 than any anyone.

The USA spends about $ 1.25 Trillion (2007) on entitlement programs (welfare, social security, Medicare, and other related social programs). This amount will increase rapidly every year as more baby boomer retire and collect social security and need medicine.
http://www.cbo.gov/ftpdocs/78xx/doc7851/…

The government should allow tax breaks and other incentives to get PRIVATE money into alternative energy.

The US should use and develop our own energy which we have and could develop, but no one wants a nuclear power plant in their home town.

As a result of that "Toxic Substances Control Act" (Clean Air Act), [15 U.S.C. §2601 et seq]. we have not had a single new oil refinery built in the USA (for our own domestic oil benefit) since 1976.

Toxic Substances Control Act
http://www.epa.gov/lawsregs/laws/tsca.ht…

"There hasn’t been a new refinery built in the U.S. since 1976, the result of extremely tight environmental restrictions, not-in-my-back-yard community opposition, and the high cost of new construction."
http://www.msnbc.msn.com/id/6019739/

The government's role is not to create jobs. That thinking would be shared by socialists. The gov can lay the foundation and set up the rules for the private sector to create jobs.

Japan obviously went through a bit of restricting since WWI, but so did the rest of the world. Japan is the #2 economy after the USA.
http://en.wikipedia.org/wiki/Economy_of_…

Japan has not recovered in 19 years from the housing bust of 1989. The Nikkei-225 Index (Japan's major market index) is still down about 50% from their 1989 high.

"The (Nikkei-225) average peaked at 38,915.87 points on December 29, 1989."
http://www.nni.nikkei.co.jp/FR/SERV/nikk…

Chart
http://en.wikipedia.org/wiki/Nikkei_225

"Bailout"
So is a bailout of US banks a solution? Yes, it is a solution. Is it the only solution, no.

Keep in mind that despite incorrect belief, the US tax payer is not just handing out a $700 billion check to banks.

We would be buying up real estate ASSETS with that money, but not all at once. Homeowners would pay the gov for their mortgage. After 25-30 years, hopefully real estate price would be higher then, verses now. Then the US gov could and would sell those properties at current market prices. Any gain would go to the Treasury (the tax payers).

If structured correctly, the amount of money the tax payer could make could pay for a lot in the future.

If housing grows at just 3% a year for the next 30 years (assume 30 year mortgage) on average, that $700 Billion would grow to $1.699 Trillion.
http://www.moneychimp.com/calculator/com…

This does not include the interest earned by tax payers on the mortgages.

In addition, I think it would be wise if the government REQUIRES all banks who participate in this "bailout" to GIVE the Treasury (the tax payers) rights or warrants and or Senior Preferred Stock (legal term is "Senior Liquidation Preference") to own part of the bank's stock. So if the bank makes money in the future, the Treasury (the tax payers) make a profit off their stock.

Senior Liquidation Preference
"A series of preferred stock has a "senior" liquidation preference when it is entitled to receive its liquidation preference before another series of preferred stock. "
http://www.fenwick.com/vctrends/VC_Terms…

Preferred Stock
http://www.investopedia.com/terms/p/pref…

I think this is a fair risk exchange for the Treasury (the tax payers) to take on all the bad banking decisions. So now we have several ways for tax payers to make money on their investment.

1. Rights, warrants, and or Senior Preferred Stock of ownership in such banks we bail out. Preferred stocks often pay quarterly dividends. We make money while we wait for a return on our $700 Billion investment. We profit on the banks growth in their stock price, when banks earn money in the future. We lose nothing if they don't.

Banks can pay the Treasury a PREMIUM now, for the right to buy back the stock, warrants, etc, issued to the US Gov at a profit say 50%. I figure as long as the bank doesn't fail in the future, the stock should easily have grown by 50% over 30 years.

Wachovia is up 87% (interday trading, 09-30-08 ) one day after they were taken over by the FDIC and handed to Citigroup.

2. We make interest on existing mortgages we bought with that $700 Billion. Some will default, yes, but tax payers get the house to hold or sell it for cash.

3. Mortgages that are held to maturity, (25-30 years from now) tax payers get fair market value of home prices in the future. That alone should pay off the investment. But I still think we should penalize the banks for making bad decisions, and say if you want tax payers to take on this investment, we want part ownership with the opportunity to share in the profits of your good assets too.

This is exactly how the Citibank - Wachovia deal was structured with the FDIC.

Video
http://www.cnbc.com/id/15840232?video=87…

Summary:
"Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk."
http://www.bizjournals.com/stlouis/stori…

So, how the proposed bailout is structured will answer this question. And how the markets react to it, will be the "final answer."

It would be nice if we could get all the billions of unnecessary pork barrel spending OUT of any bailout bill. This is Congress taking advantage of taxpayers in order to save the banking system. This is not a time to fund billions in "pet projects" during an election year.

Congress and the media need to sell this idea to taxpayers in these more realistic financial terms and not just (incorrectly) paint it as a "tax payer bailout of Wall Street.”

Source(s):

--- Risk Management Consultant (19 years in the markets. See bio for more).

Asker's Rating:

Asker's Comment:

Thanks a lot for everyone. Your input has been very informative. I have found a few likely alternatives to bailout and i would share it here:
http://dealbook.blogs.nytimes.com/2008/0…
http://search.japantimes.co.jp/cgi-bin/e…

Answer 2

At some level bailout seems workable, almost like the certain answer to solve the problem. At some level.......when you realize the mess we have is because of over extending credit to those who can "afford" the credit, what makes one think that creating a additional pile of available credit ( know that 700b X 25, which is the amount of times a bank can loan against a cash deposit in their bank vault) and you see a possible increase of debt on the streets in excess of $2 trillion.

Now how does adding more debt solve a problem of too much bad debt?

This is why I think the congress will not pass any Bail out plan......let the charade come apart on its own accord....and then pick up the pieces and build something better out of the ashes.

Answer 3

1) Because we don't have 700 billion dollars. If we were to spend that amount of money, every cent of it would be borrowed.

2) Because the Republican party has been in control of government for years, and they don't believe in public schools or alternative energy, etc. A quote from Grover Norquist describes Republican goals, "I'm not in favor of abolishing the government. I just want to shrink it down to the size where we can drown it in the bathtub." Therefore, they have no interest in investing money in anything of value. Their whole strategy is to spend money where it has no value, like wasting it on the Pentagon, so that the government will be destroyed much in the way that the government of the USSR was destroyed, by excessive spending and excessive debt and idiotic economic policies.

3) What you are describing is a very Progressive, Liberal approach to economics, and a Republican president would not sign it. The only reason a bailout is under discussion is that the Republican President asked for it, signalling that he would actually sign it. He didn't actually want it, either, but reality has a way of getting in the way of ideology now and again. However, ideology rules in Congress, and he cannot get enough support from HIS OWN PARTY to get it passed.

4) It will take time for your solution to work, and during that time, banks will fail, businesses will fail, people will lose their life savings and their jobs and their homes. Tent cities are already springing up across the nation. Google it.

All in all, though, it's a great solution, and I'm all in favor of it. Vote for Progressive Democratic candidates for state and federal office, and you might even see it happen.

Answer 4

Behind the curtain, so the rich stay rich and the poor stay poor.
Really, it's because if big companies were to fall there would be big consequences on the overall economy probably leading to a depression.

I'm from Canada but i'm sort of following recent evens.

IMO though, like an overgrown forest, a "forest fire" is needed for a fresh start. I mean why does a multi-billion dollar company who's making billions in profit a year still look at ways of cost reducing for bigger profits. Greed. A new way of thinking has to be issued in and the fall of the old ways has to come sooner or later.

They dug their grave, let them dig themselves out.