10 Years On, Did The Bailouts Work?

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by: Holmes Osborne

Summary

It appears that the rich have been getting richer and poor getting poorer.

The bailouts helped investors, home owners, and pensioners.

The bailouts hurt people with no assets.

The price of apartments and housing is unaffordable to the average person in many parts of the country.

The answer to the title is “yes” and “no”. It depends upon who you are. If you own assets, it probably helped you. If not, it probably hurt you.

Emergency Economic Stabilization Act of 2008 allowed the Department of Treasury to buy bad assets from banks. As you may remember, banks were making loans to home buyers who could not afford their mortgages. When the housing market and economy cooled off, home buyers were upside down — meaning that they owed more on their homes than the home was worth. Many people simply walked away, handing the keys back to the bank.

When a bank’s debts are greater than its assets, the bank becomes insolvent. A bank’s assets are the loans and investments that it owns. Its liabilities are depositors’ accounts. At the time, George Bush was President, Henry Paulson was Secretary of the Treasury, and Ben Bernanke was Chairman of the Federal Reserve. Major companies that received money included: American International Group (NYSE:AIG), Fannie Mae (OTCQB:FNMA), and Freddie Mac (OTCQB:FMCC). Bear Stearns, Lehman Brothers, and Washington Mutual went bankrupt.

Bank of America (BAC) was given $20 billion to buy brokerage firm Merrill Lynch and guarantees of $100 billion for any bad assets that it bought. Citigroup (NYSE:C) and other banks too numerable to mention received bailout money too.

As you can see from the graph above, housing prices sank. They only began to recover in 2012. Property owners saw the value of their real estate plummet.

The Dow Jones (^DJI) sank too. Investors saw their portfolios get slaughtered.

So where did all of this money come from? The Federal Reserve can buy back Treasury bills and other investments from money that it creates from thin air. Until 1971, we could not do this as the dollar was pegged to the price of gold. One ounce of gold equaled $35.

In 2008, our money stock, called M2, stood at $7.7 trillion. It now stands at $13.8 trillion. Does this lead to inflation? Some people say no, but I would disagree.

As you can see, the Consumer Price Index took a hit in 2009. The Index is up about 15% since 2008. So some would say that transportation, food, medical care, and the other constituents have not grown much in value. Why has the CPI not grown with so much money being put into the system?

Gross Domestic Product is calculated by the money supply times the velocity of money. The velocity of money is how quickly money is being spent.

The velocity of M2 is 1.4. As you can see, in the 1990s, it was as high as 2.2. The velocity has come down quite a bit since then.

So did the bailouts work? Sure, if you worked for Merrill Lynch and got some of your retirement (it used to pay brokers partially in restricted stock) saved. If you own a home, apartment building, or any other piece of real estate. This would be tens of millions of Americans. If you live on a pension, the investments inside of the pension were saved. The bailouts did indeed save millions of people but not everyone. Folks who don’t own real estate, investments, or have a pension were not saved. In fact, they were hurt.

This story tells of a young lady who rented an apartment in Los Angeles for $1,300 a month. Her landlord was making improvements and raised the rent to $1,900. What is good for the landlord is not good for the renter. Cities like Los Angeles and New York are difficult to afford for working people like school teachers, nurses, and police officers. In Los Angeles, renters now work for companies like Google and Yahoo. You need a degree in computer engineering from an Ivy League School. Even with a $15 minimum wage in Los Angeles County, you cannot rent a place without roommates.

Wealth works like this — the person with more money gets to buy something that the other person wants but cannot afford. With investment portfolios, investors sell assets to buy second homes, art work, top notch health care, fancy cars, and other desired goods and services. You want to be the saver/investor/pensioner. Not the person with no cash and investments.

The above graph is the Workforce Participation Rate. In the mid-1990s, about 67% of people who could work held a job. Now, it’s about 62% and falling. Why? Many people do not have the skills to acquire a job that affords them a good lifestyle. The jobs are there, they just aren’t fun and don’t pay a lot. You can find a job as a dish washer all day long, but who wants to make $8 an hour? Why not take food stamps (SNAP), Medicaid, and Section 8 Housing? Then, if you need cash, work on the side and don’t report the income. This is a situation that we have created here in America in part by the way that we handle our government’s finances.

Microsoft’s (MSFT) has been a five-bagger from its nadir in 2008. That means Bill Gates’s net worth has about quintupled from the bottom (not counting charitable donations). The rich have gotten richer and the poor have gotten poorer. Not only have the rich gotten richer, but the super-rich have gotten much richer.

Oracle (ORCL) founder Larry Ellison has been gobbling up prime property in Malibu, California. He now owns 15 homes. The guy with a $5 million net worth can’t compete with Larry Ellison’s $54 billion net worth.

The U.S. has become a very competitive country to make a decent living. My definition of rich is any person who can buy a home in Los Angeles or New York City. You’ve either got the cash, assets, or income to acquire a home and it takes quite a bit of money by standards of the average U.S. citizen. You have to have a highly specialized skill to make it. Woe be to the student not paying attention in high school. That student better get some skills of some kind.

The way that we handle our government’s finances exasperated the situation. Sure, the bailouts helped many Americans, but it did not help folks with no assets.

There are other arguments against the bailouts and they have merit too. One is moral hazard. Bankers may take risk if they think the government will bail them out. We still have banks that are too big to fail. I’ve heard a Fed governor state that we’d still bailout the largest five banks. Another is picking winners and losers. Why did Bear Stearns and Lehman Brothers go under but not AIG?

It seems that the $21 trillion debt that our federal government has keeps growing and growing. And it seems the rich keep getting richer and poor keep getting poorer.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.