The good news is that, while the Bush administration's rescue plan probably won't eliminate the pain on Main Street, it will help.
The U.S. is still in for a recession, economists say. That's inevitable, owing to steady blows from the housing slump, the failure of financial institutions, commodity price spikes and declining exports.
"The economy has endured so much adversity already," says economist Robert Hansen, senior associate dean at Dartmouth's Tuck School of Business. "The fact that we are not in a recession yet is incredibly surprising."
What the bailout will do -- with a bit of luck -- is lessen the severity of the downturn by providing banks with much needed capital through government purchases of the toxic securities linked to the mortgage mess. And that should provide relief for some economic sectors with very real impact on Main Street.
Will the bailout stop a recession?
In recent months, credit has become difficult to come by, as the failure of a few large banks has made other banks anxious about lending.
"Capital shortage is the problem," says economist Anil Kashyap, a professor at The University of Chicago's Graduate School of Business and a former economist on the staff of the Federal Reserve. "If people can't borrow, it will impact the consumer and business spending, and that is how we slide into a recession."
Put another way, federal officials need to encourage borrowing and spending, right now, because borrowing and spending will cushion the downturn. While the program starts by putting more money in the hands of banks, the hope is that some of the money will filter through to purchasing decisions affecting housing and autos, eventually lifting the broader economy.
Help for homeowners
The recent decline in home values and the tightening of credit markets have hit hard at homeowners' creditworthiness and purchasing power. Today, it's tough for homeowners to use the equity in their homes to obtain financing for big-ticket items, such as a child's college education or car purchase. Banks are just too nervous to lend.
And many homeowners continue to see rates on adjustable rate mortgages ratchet up, casting doubt on their ability to pay.
One of the better indicators of anxiety among banks is the interest rate international banks charge each other on short-term loans, a rate known as the London Interbank Offered Rate (LIBOR). In recent weeks, LIBOR has risen steadily, fueled by fears of bank defaults.
LIBOR may sound pretty far removed from Main Street,
but for millions of mortgage holders in the U.S., it matters, because more than half of the adjustable-rate mortgages in the U.S. are tied to the LIBOR. When the LIBOR goes up for a sustained period of time, so do interest rates on those mortgages.
By helping banks, the rescue program is likely to restrain further increases in LIBOR, or drive it down. That, in turn, would drive mortgage rates down, or forestall increases. Call it trickle-down bankonomics.
Here's how that would work. Right now, fear has totally shut down the market for mortgage-related securities, though most of these securities still have very real value. Government purchases will help re-establish a functioning market for the securities, and ultimately re-establish their real value in the marketplace. Any increase in the perceived value of the securities would tend to strengthen the balance sheets of banks and reduce anxiety about bank defaults.
That, in turn, would tend to make banks more willing to lend, holding the LIBOR rate down. At the end of the day, a lower interest rate for banks means a lower adjustable-rate mortgage for many U.S. homeowners.
By putting more capital in the hands of banks, the rescue plan will help in another, more-direct way. It will provide additional capital for banks to grant mortgages to would-be homeowners. As new homeowners buy houses, they take excess inventory off the market, creating a more healthy balance between supply and demand, and bolstering home values across the board.
Analysts agree that an end to the slide in home prices will be the most important step toward ending the crisis.
The automotive industry gets a lift
After homeowners, the automotive industry has perhaps the most to gain from the bailout. Car makers and dealers have endured one of the worst years in more than a decade, thanks to consumer spending cutbacks and an inability to provide financing for would-be buyers and lease owners.
Dealers are in deep trouble. The number of dealership foreclosures increased 46% in 2007 compared with the prior year, according to the National Automobile Dealers Association.
By reducing pressure on banks, the rescue should relax financing standards, enabling more customers to qualify for car leases. And any improvement in the housing market will boost automotive sales by enabling more consumers to use their home equity to buy cars.
"I hope it improves business," says Jerome Barnes, a sales consultant at Saturn of Paramus (N.J.), who has seen customers walk away after being denied financing.
Help for car dealers?
Detroit has other reasons to cheer the rescue. The bill includes $1 billion in tax breaks over the next decade for the purchase and development of electric cars. That addition doesn't address problems resulting from the credit crisis, but it does help automakers restructure their businesses in the face of rising fuel prices. In the long run, the tax breaks will help the industry.
Security for small business
The problems facing small businesses may be the biggest threat to the broader economy. Small businesses frequently need short-term credit to meet payrolls and fund new projects. Entrepreneurs look for credit to fund startups. No credit means fewer jobs. By helping banks, the rescue will likely increase their willingness to support small-business initiatives.
Moreover, the extension of federal insurance to cover deposits up to $250,000 clearly helps small-business owners. The prior insurance limit of $100,000 covered all but the wealthiest individuals. But business owners operate on a larger scale and are far more likely to have that kind of cash sitting in a checking or savings account, where it can be easily withdrawn to pay employees, rather than in long-term investments. So this change means a lot to them.
The bailout's not a panacea
Despite the benefits of the bailout, it's not a cure-all. Some banks will still fail, cautions economist Lawrence White, deputy chair of New York University's Stern School of Business. As those banks go under, would-be borrowers will see less competition for their loans and, likely, less-favorable terms. That's not to mention all the bank employees who will face layoffs.
Still, by cushioning the impact of the crisis and helping banks avoid an even worse meltdown, the bailout should ward off a deeper recession.
"The recession train has left," says Hansen. "The hope with the bailout is that we avoid a very serious credit contraction."
Published Oct. 7, 2008
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