What, one might ask, would happen if they don't pass a good bailout plan? Here's a quick summary.
No one will be able to get a mortgage unless they have 780+ credit (top 10%), a large down payment, and high income
- Why? Most banks that give out mortgages will become risk-adverse, because they will not have access to easy credit from other banks (see below)
- Result: Real estate market will crash (further). Houses will not be able to sell. Prices will decline another 20% from peak value.
Small companies will not be able to get loans and credit issuers will likely decline their line of credit/credit limit
- Why? Bank will become weary of lending without collateral (but then, they won't except a house anymore, anyway) and credit issuers, stung by high defaults and low cash flow, will look to shore up their books by reducing potential liabilities
- Result: Several small businesses go bust; their employees are layed off; business investment crashes
Large companies, especially large banks, will not be able to access enough money to shore up their balance sheets.
- Why? Fear in the market causes investors to hoard cash and treasury bonds. This contracts the money supply.
- Result: This will cause investors to lose confidence, creating a self-fulfilling prophecy in which: 1) the stock price decreases; 2) the bank's commercial paper (read: bonds that companies use to raise money for operations) loses value; 3) rating agencies downgrade their rating of this paper; 4) investors sell this paper; 5) bank cannot find buyers for this paper; that is, they can't find people to lend them money for their operations; 6) their cash flow decreases to the point at which they can no longer give out loans and, eventually, allow withdrawals from accounts (ie. no ATM); 7) the bank fails. For every bank that fails, other can potentially fail, because banks lend to other banks. Eventually, if enough large banks fail, half of the banking industry could collapse.
Local banks fail.
- Why? Because they invested in larger banks, rapidly falling equity securities, or in mortgage-backed securities
- Result: This will kill small business across the country; damage local governments; create rampant unemployment; and essentially eliminate the ability of any consumer to get credit, mortgages, car loans; student loans; etc.
General results:
1) The auto industry in Detroit will completely collapse, even perhaps with government intervention, due to its ability to sell cars to the US market. (That is, consumers can't get car loans.) This will send Michigan into depression-like conditions. The US Auto industry will be unable to recover its standing in the world.
2) The banking industry in the US will be decimated. Much of it will be nationalized and in the hands of a couple large banks, like JPMorgan. At least 2-3 other large banks will likely fail. Wachovia is at the top of the list. Wells Fargo has recently become a good candidate. And Bank of America may as well, due to their recent acquisitions.
3) The shadow banking industry (hedge funds, credit default swaps, private equity) will likely collapse, destroying a trillion dollars of wealth, if not more.
4) The Dow Jones Industrial Average will sink below 7,000, representing a more than 50% decline from its Oct 2007 peak value.
5) Unemployment will top 8% by year's end and may hit double digits by April of next year.
6) The insurance industry will suffer catastrophic losses, which will damage several reinsurance companies in Europe.
7) Consumer spending will contract at rate that hasn't been witnessed since the early 1930s
8) Downward spiral ensues
Fortunately, most of this will not come to pass, because Congress will pass a good package to help prevent it. Right? Well, the package presented today is probably too vague to be successful. They need to insert more safeguards and work to ease lending between banks. If they don't do this -- or if the Republicans roadblock the plan in general -- well, see above.
