Economic Crisis – understanding why the bailout was proposed

(reposted from a comment I made in filkertom’s LJ)

This may be useful for you:

A lot of what is happening right now has to do with money markets and short-term liquidity, which is drying up. When people hear “the banks can’t lend money”, they just assume it’s John Doe borrowing money to buy a house or a car or something like that. Not so.

Here’s an example:

Bob’s Cleaning Service (BCS) employs thousands of people. Every day, BCS goes and cleans some offices, and people write them a check in order to pay for their services. Now, that money doesn’t instantly appear in the BCS account – it has to go through the system and will be in the account in a day or two. So BCS has to make payroll on Friday, and they’re $900k short, since they’re waiting for things to clear through the system. So they go to the bank and say, “Hey, we need $900k for two days, at the end of two days we’ll give you back $900k plus $1k for a lending fee.” The bank says sure, passes the money over to BCS, payroll gets paid, and two days later BCS pays the money back, plus a small lending fee.

Now, the problem is that people are terrified of the market’s stability, and are pulling their money out of the money market – and here’s where I’m a little fuzzy on the concept, because it has something to do with the money markets, which involve banks and bonds and such, so you really need a better economist to explain that part. But, if there’s no money in the money market, it means the bank doesn’t have money to loan, because people have removed it. If the bank can’t loan BCS $900k on a short-term basis, BCS can’t make payroll (or pay for supplies or gas for their trucks or pay for their operating costs, etc.). If BCS can’t do this for even one day, things start to go very badly. Payroll gets delayed, the cleaners can’t get to the sites, they don’t have the equipment they need, etc. etc. In just a few short days BCS can lose a whole lot of revenue because of delays and breakdowns in their workflow.

And this is the real crisis – not “John Doe can’t borrow money for his house or put money on his credit card for a vacation to Bermuda or a bunch of stuff he doesn’t need.” It’s the day to day businesses coming to a screeching halt because they don’t have the money moving through the system like they used to – people don’t get paid, people don’t get the services or goods they’ve paid for, and it snowballs until it all comes to a slow, grinding halt.

This is why people are screaming for the bailout.

Now, it’s not that I am endorsing the bailout. I think that 3-page piece of crap that Bernanke handed to congress about “Give me all the money and the power or we all die” wasn’t worth the paper it was printed on. It should have been rejected outright and Congress should have started over, instead of trying to take the piece of crap and make it smell nice. But something has to keep the markets moving or things will go very badly very quickly.

This isn’t about consuming and more more more. It’s about the pace of our society and the speed of business, and how quickly it can be brought to its knees. Objects at rest tend to stay at rest, and if we let the economy stop, it’s going to be very hard to get it moving again.

(Sorry for the long post. It’s just I’ve been trying to follow this crisis closely and I have a lot to yammer about.)

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