My kid, fighting for our freedom in Iraq, wrote to me and asked, "Could you please explain to me what happened with this bailout thing using 5 dollars in stead of 700,000,000,000 dollars? I can't seem to wrap my mind around the idea."
Ok, it's not simple, even with $5 because it involves putting a bunch of IOUs together in an envelope and selling the envelope. Imagine that you and four of your friends lend a dollar each to five people who have no money, no hope to get any money, and who have cheated lots of people you know by borrowing money from them and never paying them back. "Don't worry about it," you tell the borrowers. "Just give me an IOU for a dollar and an agreement to pay me back two dollars." So you and your friends put the IOUs in an envelope. To make things simple, one buys the IOUs from the others by paying each a dollar. Let's say that person is you. You now own an envelope worth (on paper) $10. You bought it for $5, proving that you are a savvy businessman. "Hey," you tell one of your friends, "This envelope is worth ten dollars, but I'll sell it to you for six." He buys it. You are made whole--you aren't out anything. In fact, you've made a dollar. But it doesn't end there. Your friend sells it to another friend for seven. And so on until at some point someone holds an envelope he's paid $9 for, but is worth $10. No one will buy the envelope for $10.
You might put that envelope and nine others like it into a large envelope, which (on paper), is worth $100, and sell it for $91, and that person sells it for a dollar more, each time selling it and making a tiny profit until someone buys it for $99 and can't sell it. Then he puts that envelope and nine others into a really big envelope worth (on paper) $1000, and sells it for $991. This can go on endlessly until you're shuffling a duffelbag worth millions of dollars. Each time the duffel is bought and sold, a profit is made. You and your friends become rich passing the duffelbag among yourselves, each time either being very careful not to be the last person to buy it, or (if you are) that you have lots of other duffelbags to stuff into a big box and kick the value of the whole thing up by a factor of ten (an order of magnitude) and then you can sell it. This is called "leverage."
Inside, the paper is worthless, but no one worries about that because everyone is making huge amounts of money by selling the face value of the paper (a derivative).
Each time there is a sale your boss gets a small cut--maybe a penny or a nickel--so he has NO incentive for stopping the madness because the money is flowing. Some of the money you and your boss make is sent to your congressman and senators and the president for their campaigns, with the understanding, explicit or implict, that as long as they don't regulate what you're doing, they can expect much generosity. And you can take them blue water fishing or golfing in Scotland or skiing in Aspen and send them lots of Kobe beef and caviar. And while you're hanging out together at your resorts or on your yacht, you can tell him how nicely he'll be treated when he finally leaves office because he was so helpful.
Because you and your friends are such savvy businessmen, your boss gives you each big bonuses for your fine work.
OK, now it's time to collect the money. Deadbeat one offers to pay a dollar back--it's all he has. Ironically, it's the same dollar he borrowed. Deadbeat two has no money. Deadbeat three, four, and five have a quarter apiece, but rather than give the holder of their debt the quarter, which they might need, they just stiff you. OK, the envelope supposedly worth $10 and in which some fool has invested $9.99 and 99.99999999% of an additional penny turns out to actually be worth a dollar. The guy who bought the paper is out about nine dollars. The guy who paid you each a bonus is out five dollars and he'd really like you to pay him back because HE BORROWED the five dollars he paid you against the profit to be made on the worthless paper.
But he has friends in the administration, so he asks the president and secretary of the treasury to give him cash to make him whole on your bonuses AND $9 to make the guy holding the worthless paper whole. No one loses money except the taxpayer. Any individual taxpayer would go for his gun if you tried to squeeze this money out of him, but we have a representative government run by people who have more in common with the moneylenders than with the people they are elected to represent. So it's easy for them to imagine the tragedy of giving up their private jets and summer homes in Belize and sending their kids ot public schools than it is to imagine how difficult it is for millions of taxpayers to have meatless days and to cut back on driving and so forth in order to foot the bill for the bailout. So they rubberstamp the bailout.
Lessons learned: You learn that if you lend money to deadbeats, you will still make your profits--if the deadbeat won't pay you, Uncle Sucker will. Your boss learns that he can give you big bonuses no matter how badly your loans turn out because Uncle Sucker will replenish the money. Deadbeats learn that they can borrow as much money as they want and never pay it back and never be held responsible for it. And because they were so helpful to you and your boss, the politicians who rubberstamped the bailout can expect big campaign donations from you and your boss and probably a highly paid sinecure (a job where you don't do anything but collect a huge paycheck) when you lose an election or retire. It's a win-win-win-win situation unless you're a working person who pays taxes.
However, there is another layer on this mess. Our country and our world is based on investment and debt. Without it, you can't run a government or a business, you can't buy a house, you can't buy a car, you can't get a needed operation. So if those moneylenders AREN'T made whole, they might stop lending money altogether and that's what happened during the depression. It only ended when the government became the lender of last resort, the employer of last resort, etc. It got manufacturing rolling again, hired millions of men to build roads and parks and government buildings, and so on. In the US that was fairly benign, but in places like Italy and Germany, it turned into a cancer and caused World War II. Germany built the Autobahn, and Italy made the trains run on time, but generally while the US was a frontier with lots of empty space to fill, Germany and Italy had been built up for thousands of years. They had to hire hordes of unemployed people to be in the military and to build tanks and ships and planes. Plus, there were a lot of hard feelings after World War I and Germany wanted to kick its enemies a bit (France in particular--imagine losing a war to France).
In any sane world, threatening financial collapse and global war if you don't get a huge bundle of cash would be called extortion, but since the folks doing it are wearing white shirts and fine suits and are on a first name basis with the president (and probably fraternity brothers and second cousins to boot), it's called a bailout.
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