So, it looks like the Treasury is finally beginning to realize that direct capital injection is the way to go. They didn't want it in the bill, tutted when it made through and passed, and now have decided to start using it. I think that the fact the Brits did it yesterday (to the tune of an equivalent $500B, adjusted for the size of their economy vs the U.S.) had a lot to do with it. I thought it was great that it got slid in there, but I assumed that we would not see it used in this administration.
The idea is that instead of buying up a lot of toxic debt that cannot be realistically priced, the government will instead invest money into the banks themselves (and hey, probably other things eventually, like car manufacturers - just wait!). In return the government will get preferred stock, either with a promised return (like, say, Warren Buffet), or at least with priority in dividends over regular investors. This might seem unfair, but keep in mind that the other option is that the bank goes under and the investors lose everything...so a pretty good deal over all. This will provide the financial system with additional capital...and the calm and reassurance that comes with that. Hopefully the credit markets improve, and this will fix the commercial paper problems that are causing us to teeter on the precipice of doom. Also, if we are shareholders then we can call for the executives and the boards that got us into the position to be fired and their ridiculous golden parachutes (or Suckage Insurance) rescinded. Appropriate to their business acumen there people can then be offered positions as shift Managers at WalMarts across the country.
Once disaster is averted, and the banks are better capitalized, they can start to address the issue of how to fix the toxic mortgage problem. They will hate doing this since it's mostly going to involve re-writing adjustable mortgages to thirty year fixed at around 6-8% fixed apr. Reasonable, but not great for both sides, but good enough that it could keep some people in their homes. In some cases where homes are underwater banks are going to have to bite the bullet, realize how much they would lose in a foreclosure, and do what so many small business owners do when they have shelves filled with crappy product that is not moving - mark it down to reflect the the new, lower, values. They will lose pretend money, but less than they would if they foreclosed and sold at auction, probably, with all the attendant costs.
Individual home owners who took out equity 3 times the value of their house will have their Lexus cars, Big Screen TVs and other luxury items bought on credit repossessed, and they will be placed into stocks in front of their homes with signs around their necks showing the amount of actual money they put into their homes ($9000) and the amount of equity they borrowed against them ($450,000). Clanking below the stocks will be metal buckets into which passersby may place coins. Once the homeowners have collected enough coins to cover the principle (after all, we are not monsters) on their home equity loans their first mortgages will be written down to the market value and refinance as fixed rate loans. For the years they have spent in the stocks they will get a $1000 credit to use at the Salvation Army or Goodwill to refurnish their homes.
This is a good thing. This (if you ignore the snark above) is the most orderly way to approach this problem, short of having a time machine to go back and put proper regulations in place 10 years ago.
This problem is the result of a lot of things (oddly, not of any of the things John McCain talks about), and it was encouraged by deregulation from both the Republican and Democratic wings of our single party system (you do realize that we have a one party system in America, where we choose between the middle right and the far right wings of the party, while everything in the party's left of middle get's ignored, right? That's another blog post though). The only way to fix it is sensible regulation.
People don't seem to remember that markets needs rules in order to thrive. Not stupid rules though. Since I am in trucking I will use an example from there - the old (70s) trucking regulations that required everyone to charge the same for the same freight going the same distance. This is a stupid regulation that (obviously) stifles competition. The has been rescinded now, and the newer regulations have to do with safety - the maximum hours and breaks for a long haul driver, for example. This is something that makes some degree of sense, since it's regulating an area of the market that the public has an over riding interest in - the safety of the trucks on the road. Trucks also have to obey the laws of the road - speed limits, stop signs and obey maximum weight limits on some roads and clearly label dangerous cargo.
This is exactly the same kind of regulation that markets need. Keep in mind that the market is, in many ways, an artificial construct, just like a game and a game without rules is a game that no one in their right mind should want to play.
I am actually hoping that this crisis will end up being a good thing, resulting more stable markets that bubble less often and don't pop as disastrously. Maybe Milton Friedman can finally be placed up on the shelf with equally discredited economic theorists like...oh...say...Marx (really - watch Duck Soup again). We are all Keynesians and Social Democrats now.
Also, I am betting on Dow 6000 before the election. Who want's to take over/under? I'm also betting on about a 3 year recovery, with severe short term contraction and steady, but slow growth starting from there and bringing us back to near where we are today, but with much more regulated and stable markets. Assuming Obama wins. If McCain wins we will be fighting with dogs over dead rats in the street with a year, and descending into cannibalism by mid-2010. And since no one will have electricity FOX will not even be able to make a reality show out of it.
Italicized items are satirical and not intended to be taken too seriously. Note the bit about McCain leading directly to cannibalism is NOT Italicized.