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Understanding the Bailout

In: Business and Management

Submitted By vadim21
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Investment Analysis

UNDERSTANDING THE BAILOUT

Understanding the bailout

The turmoil in the mortgage and financial markets, but also fears of recession, have pushed the government to act in order to prevent further worsening of the crisis. As the situation was getting worse month by month, government bailing out one financial firm after another (Bear Stearns in March, AIG in September), and letting fail some (Lehman Bros), a more global approach to address the problem was needed. The bailout proposal, initiated by the Secretary of the Treasury, Henry Paulson, a former executive of Goldman Sachs, was intended to create an entity whereas the government was going to buy those mortgage backed securities from the banks in order to provide liquidity to the banks and clear their balance sheets of these unmarketable assets. Although nobody understands exactly what the plan is and how it will help the economy, since it has changed since the legislation was passed by the U.S. Congress (angering investors in the meantime), there is a consensus that the government will have to step in to clear up the mess on “wall street” and on “Main Street”.

In order to understand why there is a need for a bailout, I will retrace the roots of the crisis up to the point where the government decided to intervene. Also, I will address the issue of how the measures undertaken will impact on the banks, the credit markets, mortgage markets and the overall economy. Finally, I will provide an opinion as to why I think the bailout is a bad measure that will hurt the economy on the long term.

The last major bailout before the current financial crisis was the bailout in 1998, of Long Term Capital Management, a hedge fund and a one time big player on Wall Street. LTCM undertook a huge risk by engaging in highly leveraged positions, which resulted in mounting losses due to

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