By Serge Eygenson | The bailout is needed to prevent the economy from spiraling into decline.
As the demise of giants such as Bear Sterns and Lehman Brothers proves, in the volatile world of finance there are no guarantees. The US’s market economy follows a random path and no one, not even the government, is exempt from potentially bad investments. There are no promises for the success of the $700 billion Wall Street bailout approved by Congress on October 3. Nonetheless, pending the effects of several outside factors, the treasury’s plan for invigorating credit markets has the potential to prevent further disasters in the financial industry, while the economy naturally rights itself in response to the current crisis
Admittedly, the Treasury’s strategy of purchasing high-risk assets from banks, restoring the banks’ balance sheets and confidence to a level where lending is again viable, does not address the underlying issue behind the credit crunch; loose lending standards during a housing boom and a resulting spike in mortgage defaults. In the coming weeks, even as the credit market thaws in response to the Treasury’s involvement, banks’ lending practices will not come close to their pre-crisis highs. Having just experienced widespread defaults and bankruptcy, the banking system will settle at tougher, but still reasonable, standards: allowing for the daily inter-bank lending that supports the U.S. banking system and personal loans underwritten by individuals with good credit and good strategies. This allows for personal investment in small business, education, and the ailing housing market, all driving forces in the future growth of the American economy. Thus, while the bailout does not directly address the issues of easy credit and bad mortgages, it allows banks to provide loans to those qualified to receive them. If this is to happen, the economy will naturally right itself by reinvigorating the economy, and the housing market in particular, through sound individual investment.
The bailout itself is not simply a federal donation to the banking system. Actually, it is a business transaction and, in return for its investment, the government will take possession of a wide variety of currently risky assets, namely mortgages with high potential for default. As the new owner, the government can work with home owners to restructure the mortgage loans to more friendly terms, decreasing the likelihood of default and increasing the potential for return on the taxpayers’ investment. Furthermore, as banks begin to loosen their mortgage lending standards(to a degree), qualified potential homeowners will be able to invest in what, at the moment, is a market with high-profit potential. The drop in demand for housing has brought the price to lucrative lows. In many areas, purchasing a home means taking advantage of historically low prices. If the housing market begins to heat up, as fear and controversy surrounding mortgage loans dissuade, today’s home buyers can earn a large profit, or, if nothing else, improve their quality of life through better housing at a very reasonable price. As demand for high profit-potential housing increases, prices will eventually rise, creating a self-fulfilling prophecy.
While this positive outcome can prevail, it hinges on a number of variables. Obviously, the Treasury’s assumption that fewer high-risk assets will motivate banks to increase lending needs to be proven true. Furthermore, as banks’ credit standards loosen, potential underwriters must be willing to take on new loans. With daily doom-and-gloom headlines bemoaning the death of the financial industry, the public’s positive response to the possibility of increased debt is far from guaranteed. Nonetheless, just as public opinion has been swayed by negative press, it can also be influenced in a positive direction. Hence, the bailout’s potential is heavily based on its initial success, and the media and public attention that will arise. Finally, the public must reinvest into the American economy. While the average citizen could use his newly acquired loan to purchase a second-home in Florida’s troubled housing market, he or she could just as easily invest in real estate in Spain, also experiencing a sharp decline in housing values. Hopefully, the bailout will return confidence to the American economy, attracting both domestic and foreign investors.
The bailout itself is far from a panacea meant to cure all of the United States’ economic ills. Nonetheless, it can serve as a temporary crutch that allows troubled aspects of the economy to heal. Of course, the plan is not fool-proof but it has potential to rebound the economy and stop the financial system from entering a downward spiral. The fact that the plan was implemented and passed into law quickly allows it to have maximum potential effect. In an unpredictable financial market where even giant firms face bankruptcy, involving the most stable institution in America, its government, can prove to be the path to recovery.
Mr. Eygenson is a sophomore who has not yet declared a major.
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