Dear Main Street,

I understand that you have some reservations about the proposed $700B plan for the US Treasury to buy troubled assets from the banks. I don’t blame you. And frankly, I share your concern. I agree that the bill, as most recently proposed, was inadequate. Moreover, I’m not even convinced that it would solve our credit woes (for reasons I will detail in a later post).

One objection that I have heard some express about the plan is that it bails out Wall Street at the expense of Main Street. Therefore, the argument has been that the plan should be opposed and Wall Street should be left to deal with the mess it created.

It is true that there are elements of the plan that would let the fat cats on Wall Street off easier than they otherwise would; however, let me try to explain why I perceive this situation to be so grave that Main Street would not be spared at all, and that the need for action (even if imperfect action) is absolutely critical.

Don’t get me wrong, in some ways I am glad that the bill was voted down by the House of Representatives today. It needs to be retooled and reworked. But we need to get some version of it through – hopefully with better protection for the taxpayers and more stringent oversight.

But Main Street, let me try to make this clear – this plan is just as important to you as it is to Wall Street!!

Credit markets are currently experiencing unprecented stress. When credit markets are stressed (whatever the reason), banks and financial institutions do not lend; rather, they hoard whatever precious liquid assets (cash) they can get there hands on.

So why does this matter to Main Street?

Well, in the extreme (and this borders on hyperbole for the purposes of exposition), with banks not issuing credit:

Wall Street will be affected, and almost immediately. Imagine jobs disappearing from the financial industry overnight. And who knows how many – maybe orders of magnitude of 20-30% of all financial services jobs. And maybe you think, “too bad, folks on Wall Street deserve to pay with their jobs because they created this mess.” That would be myopic. Think about what mass layoffs on Wall Street would mean for government budgets of all kinds. Without income, there is no collection of income tax. It would immediately put extreme pressure on Federal, State, and Municipal budgets. Those budgets fund services upon which we are so dependent. Moreover, think about the impact on consumer spending. Unemployed people aren’t very good consumers. This would result in stress for retailers, and an additional negative feedback effect on government budgets through the sales tax channel. This is not good for you.

In addition, our federal budget is already running a massive deficit. This would force us to borrow even more from foreigners to fund domestic needs. At what point do those foreign creditors walk away?

Think too about how much stress a complete credit meltdown would put on credit lines of all sorts. Financial institutions would be forced to withdraw credit lines from all borrowers, creditworthy or not. As a result, a whole host of real economy companies upon which you depend for your needs will find themselves without credit to fund their daily operations. For the weakest of these companies, that would force them almost immediately into bankruptcy. For firms with stronger balance sheets, it would result in a huge jump in the cost of capital, severe curtailment of operations, and additional layoffs. How many layoffs, I cannot be entirely sure, but believe me, you would feel it!

So now not only would there be mass unemployment on Wall Street, but it would be coupled by mass unemployment across a swath of industries. Imagine how much pressure such mass unemployment would put on unemployment insurance benefits, which in some states are underfunded, and even if they are not underfunded, they are certainly inadequate to meet those kinds of needs.

In addition to mass layoffs, imagine mass foreclosures (even greater than what we’ve seen thus far). Folks without jobs will not be able to adequately service their debt and will be forced to hand the keys of their house back to the bank. Even those who remain employed will have difficulty meeting their debt obligations as many with adjustable rate mortgages will find their discretionary income squeezed when those rates readjust at higher rates.

If credit dries up, imagine going to an auto dealership to buy a car only to find out that a bank cannot float you the funds for the purchase. Imagine going to a store to make a purchase only to have your credit card denied – not because you are not creditworthy, but because the bank cannot underwrite the purchase. And even if you do qualify for credit, the terms would be so onerous that it would make many purchases prohibitively expensive. If you want to buy goods therefore, you have to pay in cash. But then imagine going to a bank to draw on your funds only to find that they are unavailable

All of these effects will obviously cause a negative feedback effect on the retail industry, whose sales will drop off a precipice. Hence more layoffs, less government income, less consumption, less credit, and so on.

This is why this $700B infusion into financial institutions, while deplorable and disgusting, is absolutely critical.

And as I mentioned in a previous post (see Letter to My Senators), although I can envision the economic consequences of allowing such a credit crisis to bring down our entire financial system, I cannot even fathom the social consequences. So for those of you who are ideologically opposed to this bailout, ask yourself, “Are you really ready to live with the consequences?”

In my view then, the most important thing is not whether or not to the plan should move forward, but how best to construct the plan to protect taxpayer interests and provide strong oversight.

For me, the key is, and has been, equity in exchange for capital. Moreover, I believe that Roubini’s recommendation for capital in exchange for preferred equity is a sound one.

Unfortunately, to me this plan seems like our best/last chance to stave off catastrophe. Sadly, although it provides us a chance to address the symptoms and represents a step in the right direction, it’s not entirely clear to me that it will work. I will explain why in a follow-on post.

To be continued…

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This entry was posted on Monday, September 29th, 2008 at 8:17 pm and is filed under Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.