How Big Is the Bailout?

The $700 billion “Paulson plan” (or “Hanky Panky”) is big.

In fact, $700 billion is such a startlingly large number that a surprisingly large amount of commentary has gotten it completely wrong.

For instance, click here to see the results of a Google News search on “$700 million” and “bailout.” It seems that plenty of journalists got the million/billion distinction wrong. (Plenty of bloggers, too.)

Interestingly, not all of these articles are mistaken — several were noting that Treasury Secretary Paulson is “reportedly worth about $700 million.”

How big is this million versus billion mistake? As Jon Stewart reminds us, $700 billion is equal to around 2,000 McDonald’s apple pies per American, meaning that the million versus billion mistake amounts to 1,998 apple pies difference.

But there’s a deeper economic issue here. The Paulson plan does not “cost” the taxpayers $700 billion dollars. The plan is to give Paulson a $700-billion war chest to purchase securities that have some value.

Now it might be that we are buying truly valuable securities at bargain prices, in which case we all make apple pies; or it might be that we are buying junk, and the true cost will be several-hundred apple pies each.

David Leonhardt’s splendid column in today’s New York Times does a great job in outlining these issues.


David Chowes, New York City

Every American is asked to pay lots of money for a lack of oversight by the government and by the excessive actions of THE LITTLE PIGGIES from Wall Street. And, lose their homes, jobs, ability to by the necessities of life . . .

If these W. S. persons acted like they do in making more money than anyone can use in numerous lifetimes, at dinner guests, they would never be invited back.

Boorish behavior -- courtesy of these LITTLE PIGGIES! With serious consequences for all.

MrIncognito

Why $700 billion? Try this article:

http://www.forbes.com/home/2008/09/23/bailout-paulson-congress-biz-beltway-cx_jz_bw_0923bailout.html

"In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.

'It's not based on any particular data point,' a Treasury spokeswoman told Forbes.com Tuesday. 'We just wanted to choose a really large number.' "

It's also pointless arguing what the money is being spent on. Paulson wanted $700 billion with no oversight or review, so he could have bough a beach front home in Hawaii and a lifetime supply of Pina Coladas with it. In fact, noone has really enumerated what sort of plan they have. Are we going to offer to buy common stock to restore liquidity? Are we buying crappy mortgages? We don't know. If we're making $700 billion worth of AIG-bailout style loans, that's a much different proposition than taking $700 billion worth of the worst debt in America. Until congress shakes the administration hard enough to get them to talk, we're all just engaging in speculation.

It's also ironic that as CEO of Goldman, Paulson was partly responsible for this mess in the first place. Maybe we should find someone who didn't create the problem to help fix it? There's massive conflict of interest potential.

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Craig T.

Ah, the whole "million"/"billion"/"trillion" thing . . . all just big numbers, eh?

As my sixth graders and I work together to figure out--and it helps those of us who made it past sixth grade to picture it this way--it helps to understand these numbers if you approach it as an issue of time rather than trying to get your head around the numbers (with similar sounding names that pretty much just seem to mean "big number".

I explain it this way: imagine that you're counting, say, a million people, at a rate of one person per second. How long (in hours or minutes or days or years) would it take to count a million people if you could count one per second?

The answer is about 11 1/2 days. So if you started counting now, you'd count the millionth person in just over a week and a half.

Now for a billion. If you started counting today and wanted to count a billion people, one person per second, it would take you . . .

For some, the first instinct is to say 23 days--but that's TWO million, not a billion (which is a thousand million). To count up to a billion, one second at a time, would end up taking a few months shy of 32 years.

A trillion seconds, then, would be 31,700 years or so.

Not sure if this makes sense, but I hope it points out the MASSIVE difference that those similar-sounding numbers sound.

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Christian Bieck

In one of Asimov's non-fiction books, there was a story about how people don't understand large numbers.

At at presentation about astrophysics, the presenter told the audience that according to accepted calculations, the sun was going to be out of fuel in ca. 4 billion years. A listener asked to repeat that number, and then said: "Oh, good. For a moment I was afraid you had said 4 million..."

RC

So let us make the capitalist system work.

The government puts up the money to prevent all the economic events foretold.

1. All money paid on these mortgages until the loan is resold is split between the mortgagee and the US government on the basis of the original mortgage value and the actual value. The mortgagee keeps all the inflated value(mortgage payment over current value) for the term of the US government holding period while the Fed keeps the rest of the mortgage payment.

2. The originator or current lien holder is required to sell the asset and assume all losses for said loan, and all processing charges.

3. The originator or current lien holder is is also required to pay the current LIBOR rate for the term on the loan until it is resold.

What does this accomplish?

The current lender of record is required to pay all the costs associated with the equity loss of the property which they should have know when the loan was written.

It gives them the opportunity to resell the loan for the maximum value. It costs them for the carrying of this debt for the period until it is resold.

So in the end the mortgagee wins, the government wins and the lien holder ends up covering the actual cost of the bad debt, without disrupting the market.

Isn't this what they actually are asking for?

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Pakoda

Paul - just wanted to understand what you were saying - that the payoff for a credit event in a CDS = The amount defaulted? My understanding was that the payoffs from the swaps are actually many, many multiples of the actual debt instruments they were insuring.

William

It's true that the government could make a profit on these securities, but I don't trust Uncle Sam to manage this "investment" any better than it manages anything else. And if the government does make a profit, it's not like they'll give the money to taxpayers or spend it wisely.

Daniel Wells

2000 McDonald's Apple Pie? NO, its 4586 pies!!!

You may have seen or heard from one or more sources try to explain the 700 billion bailout deal in terms of McDonalds Apple Pies. While it is technically true that 2000 McDonald's apple for each person in the US could be bought for no more than 700000000000, this figure is horribly misleading. Worse, new sources, blogs, and fake news shows keep repeating this figure without stopping to do the very simple arithmatic to see if it is the right number. If you paid 700 billion dollars 2000 pies per person, you will have over paid by roughly $394,755,163,000. I don't know about your government, but mine can't afford to waste over 394 billion dollars due to innumeracy.

Lets do this right. It won't take long, I promise. In fact, you could have easily figured this yourself in far less time than it will take you to read this post. We need to know to numbers, the population of the US and the price of McDonald's apple pies. You probably already know that McDonalds apple pies are 2 for a buck -- although the person who came up with the 2000 pie figure clearly didn't. For the population, just ask google. "US Population" will give you the answer without even clicking on a link or even reading the summary! The July 2007 estimate is just sitting there are the top, complete with the reference to the CIA world fact book. Of course if you did bother to look at the search results, you'd find that the first result gives the US Census Bureau to-the-minute population estimate (Currently 305,247,863).

700000000000 dollars / 305,247,863 people = 2293.218347609 dollars per person

2293.218347609 dollars per person * 2 pies per dollar = 4586.436695218 pies per person.

Since people don't like to get half eaten pies, we can safely round to 4586 pies per person.

My guess is that the originator of the 2000 pie figure (1) believed that the pies are $1 each, and (2) rounded 2293 down to 2000. I might forgive this mistake had my 8th grade students made it, although I still would correct them on it. However there are two wither bad choices made in addition to the first two. Does converting dollars into some product that costs a dollar really help people understand? If you really think expressing values in terms of items from a dollar or value menu, then you have been watching far too many fast food commercials. The last mistake was rounding to the nearest thousand pies. Rounding to that place value undervalued the $700000000000 by roughly $89,504,274,000 (assuming the pies really cost $1). Even for the US government, eighty-nine and a half billion dollars is a lot of money.

So please, if you write news stories for any medium (this includes you too bloggers) take two minutes to check you math, if you work for the government don't you DARE use someone else's figures without checking them. For the rest of you, correct anyone you hear repeating the 2000 pie figure.

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History

(NY Times 9/11/2003): ''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

September 30, 1999

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites.

Home ownership has, in fact, exploded among minorities during the economic boom of the 1990's. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University's Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent.

In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent.

Despite these gains, home ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.

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David

#24: If the situation is this urgent, the Bush administration had no business asking for free dips into a $700 billion cookie jar. They knew what was being kicked around in Congress, and could easily have drawn up a bill that would have passed quickly. They didn't, showing that the White House is at least as interested as Congress in deck chair rearrangement.

Another argument for restricting executive compensation: We're busy distorting the market. The right and proper punishment for companies and executives who deliberately load up on far too much risk is bankruptcy and loss of compensation. A bailout with no strings makes recklessness far too good a deal, and rewards executives for stupid and catastrophic decisions. Neither the stockholders nor the CEOs should be rewarded. We cannot allow companies to gamble wildly with no downside.

Also, can we use some of this money to keep people in their houses? Around here, houses that are foreclosed on are effectively abandoned, and trashed fairly quickly. Leave a house vacant for a few months, and vandals damage it, and thieves steal the gas and water piping, not always practicing proper safety precautions. This is a loss of real wealth, and would be avoidable if the houses were not foreclosed on. The borrowers would benefit, and so would the mortgage holders.

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PaulK

Jim, I am unclear what you are talking about. I assume you mean credit default swaps (aka CDS), but these are not 30:1 but simply the value of the payoff. That is, you get paid a derivative for kind of insuring the loan against default. If it defaults, you pay the amount owed and take receipt of the collateral and then try to get as much back from it as possible. The problem is that these expose you to huge payments if many default at once. This is where Fannie Mae and Freddie Mac came in as well as various speculators.

The point is that many people holding the actual loan packages (mortgages), would use a CDS contract to secure it against loss of principle to lower their risk. The hard part is that many of the sellers of CDSes did not actually have the money, unlike an insurance company which has to set aside the amount. So, the house of cards started falling when it became clear how much exposure there was.

The downside of deregulation is that no one really knows how many "assets" are real and how many are fake. We are starting to find out now...

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Joe Smith

Lets just consider where we're at:

Countrywide and Lehman brothers are bankrupt and are GONE. Bear Stearns and Merrill Lynch have been sold in distress sales and are GONE. Fannie Mae and Freddie Mac have been nationalized and all investor equity is GONE.

Goldman Sachs had to offer Warren Buffett huge returns to attract $5 Billion in new capital. Morgan Stanley is offering a big slice of itself to foreign investors at bargain basement prices. Both Goldman and Morgan have had to change their fundamental nature.

AIG has agreed to punitive financing terms (8% per annum fee on the UNDRAWN portion of the credit plus 80% share dilution - and Congress is concerned that Paulson is being too soft on the financial companies) so that the interest of the equity investors is almost completely GONE.

Congress is just dithering over the alignment of the deck chairs. At this rate, by the time they're done, the whole world is going to be underwater.

The real things they need to be talking about is whether this is going to be enough and what can be done to deal with the corrosive effects of credit default swaps. Some legislative response so that the payouts on CDSs cannot exceed the losses on the underlying securities would seem to be in order.

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Alex

When assessing the government's risk in overpaying and unjustly subsidizing wall street people are making the mistake of treating it like a company.

In business if one company overpays, well, that's its loss. The other company earns extra.

But this is the government. If six months, or a year, or five years down the line government experts determine that the American taxpayer has been fleeced what prevents them from taking ownership of the investments of their choice until the balance is even? Call it a windfall tax for making too much money with our money.

kevin

That's a replenishable 700 billion war chest. The legislation allows him to hold 700 billion at any one time. So, after buying 700 billion and selling it for X, he can then go and buy 700 billion more.

jim

Jon Stewart was commenting on a "news" story that "explained" the amount of money involved as being the equivalent of 2000 McDonald's Apple Pies for each American citizen.

He didn't make the original comparison.

As for the "actual" cost, if there is no transparency, no oversight, no accountability, - as Paulson wants it- it may as well just cost $700 billion right now. We'll never know.

and I thought this problem was caused not by defaulted Mortgages, but by the Credit Default Swaps that were woefully underfunded? Yeah, the defaults triggered them, but the CDS is what made this into a huge sh**storm.

Are we buying up those CDS?

If so, they are underfunded from what I understand by a factor of like....30:1

How do we get our money back on that again?

Bobby G

First, the pie argument is boring and pretty irrelevant. That's not how the policy is being implemented.

Secondly, MrIncognito (#38) has it right. The reason why banks are in trouble is because there are laws and regulation in place that banks must adhere to when liquidating foreclosed siezures. When the market is down, the banks can lose money. They don't have time, legally, to sit around and wait for the market to improve. When the market doesn't exist (like the housing market), banks essentially have to chalk in an accounting value of 0 for any homes they sieze. So their loan of $1.2 mil on a $1.4 mil house now becomes zero. That "made up" money is now gone.

It's not just the bank's fault either, it's the homeowner... he bought a house that he couldn't afford. People like to say "Oh the banks made all the profit the past few years and now we're bailing them out?" No the banks are not just the only people who benefitted, the common guy did by being able to live in a house that he had no right living in because he couldn't afford it.

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T-Bone

Wow, how about that 700 trillion bailout...

I don't think most people have really get a sense of the number when dealing with large numbers such as you'll typically see in government. How many people think ending pork barrel spending would solve our budget problems? Besides John McCain I mean. I think people would tend to be more outraged at hearing about a 600 million loss, and less outraged at a 30 billion loss. And 2 trillion is chump change.

BTW, I think you mean 2000 apple pies for each person in the US. Unless those apple pies cost 350 million each...

Paul K

Joe (43), I disagree that what evaporated is house values (that is the after effect). What evaporated was the value of mortgage packages, CDS values, the credit market, and credibility. The loan defaults occurred before houses lost value - but those foreclosures (in record numbers) certainly depressed the house values along with a tightened/closed credit market. The decreasing value of loan packages caused the rollover loan market to evaporate which meant credit went away at ibanks and the like, and so the value of those ibanks and other institutions also evaporated. Triggers everywhere.

But, you are right that we will likely pay, although that is not certain. Remember, when the Gov bought out mortgages in the great depression, the taxpayers actually made money in the end. We are only risking $700B, the actual amount to lose or gain is yet to be written.

MrIncognito

"According to The Tax foundation, using 2005 income figures, the top 1% of taxpayers (income above $364k) pay 40% of income taxes"

Income taxes are only like 50% of US gov't revenues, and an even smaller % of state and local revenues. They also consume a proportionately larger chunk of the overall tax burden of lower income people. Apportioning the debt based on income taxes alone is just silly.

Joe Smith

"the morons that made stuff up that later evaporated should pay."

What evaporated was house values and the morons who made it up and who will eventually pay, one way or the other, is the general public.