Reflection on the initial rejection of the rescue package

Originally written on Sept 30, 2008

I watched with disbelief that the majority of people in the country did not like this rescue plan. What are the implications in the political arena and in our communities?

- Political Arena:
The stock market (the Dow) was only down 777 points because investors and traders believe that either those members of Congress who are posturing will come around and support the bill, or that some members of Congress were scared to see what happened in the market and will end up voting for the bill. But its passage is not a certainty: on a micro level, if a member of Congress were given two choices: a high probability of keeping his seat and let the economy tank by voting no, or a high probability of losing his seat but save the economy, what would he choose? His job or the bigger economy? Losing the power and prestige of being a member of Congress, or not get elected and need to find a job? The choice is clear. If the stalemate continues, the stock market is poise to go down further.

- Communities:
What people can't see is the credit market behind the scenes, which is not really functioning now.

The reasons why this bill is extremely important are that:
(1) wage payments are at risk: businesses, big and small, use short term lending to obtain the short term cash needed to pay workers. Now that banks are very unwilling to lend to each other and investors unwilling to buy short term debts so companies can borrow, businesses would face a cash-crunch and possibly unable to pay their workers and bills due to a lack of short term liquidity.

(2) jobs are at risk: when businesses cannot pay each other and their workers, what is the reason for holding on workers? Labor hoarding takes place when businesses think that they would weather the storm, and that it is cheaper to hold workers than to let them go and need to find new ones when the economy picks up. But it appears that both for the short and medium term, the economy will not recover, so letting workers go seem to make business sense, when the survival of the business itself is in question.

(3) purchases are at risk: when lending to businesses is not taking place, then lending to consumers is not likely to take place either. Borrowings have been the engine for the consumer-led growth in this country, both in terms of getting cash by tapping the equity of one's home, or borrowing to buy things, such as car loans, credit card loan, lines of credit or personal loans. With little to no lending, there will little transactions. Hence, those who need the money by selling things could not sell them, further eroding the financial situation of households.

(4) on the consumer side, capital preservation prevails and substantially slows the economy: banks are unwilling to lend to each other because they do not trust lending money to others and they also want to preserve what they have. Likewise, people would want to preserve their cash and assets, so they spend less and hoard more. Given the economic situation, enough people will be doing that that consumer-led economy will experience a substantial slowdown.

(5) on the investment side, business will not invest and housing will not pick up: internally, businesses have substantial problems borrowing, which put a constraint on what they can do. Externally, the pull-back in consumer spending will limit the appetite for businesses to expand or maintain the current operation. A contraction could happen as a result. On the housing side, borrowing difficulties simply crimp demand, as everyone knows.

(6) on the export side, the relatively strong dollar and tight credit will hamper the export sector: the US economy is weak, but others are weaker. Of the 5 largest economic entities, US, EU, Japan, UK and China, the first 4 may be on the verge of or are already in recession and China is slowing down. The relative weakness of most other economies makes the USD stronger, which hurts exports by raising export prices. This weakens the demand for exports. Even if the effect is not that large, the difficulty in obtaining credit to finance operations and expansions will hamper the production side for export

(7) the government is hardly an economic engine: the money that the government has spent is not enough to lift the GDP. A lot of that money actually went to buy up financial assets, which are not "productive" in the economic sense.

(8) the credit situation may further discourage foreign investors to lend to the U.S. The weak economy is not attractive to foreign investors. Foreign investors, which in large part have been financing the boom in the credit-driven US economy, would not be as willing to buy US debt (ie, Treasury). The smaller demand drives interest rate up, making the debt financing and repayment more difficult. This filters down to the broader economy, where the credit market is already under tremendous stress. In addition, a bad economy reduces tax revenues and weakens the government's position to pay off the national debt.

Finally, some say that it is wrong to bailout these financial services firm because of the high pay and severance packages these heads of corporations receive. But given the gravity of the situation, comparing the benefits that a $700 billion would bring, vs the, say, $700 million or $7 billion, of cost that could go to these people, quickly tells a story that the 1% of cost is minimal. One doesn't have to deal with those people now.

Deal with what's urgent and important now. Wake up and stop the bickering.