Meltdown 101: Why no direct bailout to consumers?

[November 26, 2008]  NEW DELHI (AP) -- Amid populist discontent about financial bailouts targeting Wall Street and banks, government relief programs announced Tuesday also appear at first glance to take a trickle-down approach, with the financial system first in line for help.

The immediate beneficiaries aren't ordinary people struggling with money problems; they're Fannie Mae, Freddie Mac and institutions that hold securities -- investments, in other words -- backed by consumer loans.

But a closer look reveals the new programs are aimed squarely at Main Street. Unlike Sunday's bailout of Citigroup Inc., this time the money is expected to flow to average people, through less expensive and more readily available consumer and automobile loans as well as new or refinanced mortgages.

Here are some questions and answers about bailouts and struggling consumers:

Q: Where's the money going in the latest bailouts?

A: The government's newest packages total $800 billion.

The Federal Reserve will pay up to $100 billion up to take over debt held by mortgage giants Fannie Mae and Freddie Mac as well as the Federal Home Loan Banks. The Fed also will buy $500 billion in mortgage-backed securities -- pools of mortgages that are bundled together and sold to investors, and backed by government-sponsored enterprises like Fannie and Freddie.

And the government will lend up to $200 billion to holders of investments backed by various types of consumer loans.

Q: So isn't that money essentially going to Wall Street, rather than me? Just like the other bailouts we've seen?

A: Yes and no. While institutions will directly see the money rather than individuals, those institutions make up the foundation on which consumer access to credit is built.

For example, Fannie Mae and Freddie Mac buy mortgages on the secondary market -- they acquire existing mortgages from lenders, so those lenders can in turn make additional loans, spreading risk and making more money available to borrowers.

That's how it's supposed to work. But fears about the financial system and Fannie and Freddie's health have made mortgage rates unusually volatile. Borrowing costs haven't sufficiently stabilized or fallen enough to entice many would-be home buyers to take the leap and help the housing market rebound.

Tuesday's moves are intended to put lenders on better financial footing to extend mortgages carrying lower rates, and offer them to borrowers who otherwise might seem too risky amid the credit crunch.

By purchasing some of Fannie and Freddie's mortgage obligations, the government "could help improve their credit ratings, and then they can get mortgage rates to go down," said Laurence Kotlikoff, an economics professor at Boston University.

Q: So, now the government is lending up to $200 billion to investors holding securities backed by consumer loans. How will this help me get a less expensive loan for a car, or college? And how might it help me get a higher limit on my credit card?

A: Banks and other institutions that provide small business loans and consumer loans issued about $240 billion in securities last year, raising cash from investors to help finance their lending.

But the market for those securities essentially ground to a halt in October. That's left lending institutions without access to cash to make loans. They've responded by lowering credit card limits, tightening standards for who gets a loan, and boosting interest rates.

The government's infusion is designed to get more money to lenders. That's expected to spread benefits throughout the economy by putting it into the hands of consumers, in the form of more available credit and easier mortgage financing. That's key to improving the overall economy, since consumers account for about two-thirds of all spending.

"If consumers can't avail themselves of consumer credit, they won't spend," said Art Hogan, chief market strategist at Jefferies & Co. "And if they don't have the ability to refinance their mortgages, there will be a drain on discretionary spending."

Q: Why did it take so long for the government to start tailoring its bailouts to help consumers more directly?

A: The government has tried to directly help consumers this year -- remember the $600 rebate checks we got from the federal stimulus package? But this didn't stop the bleeding -- the economy continued to decline.

After the slump deepened in September, many of the subsequent bailouts were short-term steps to prevent immediate failures of banks and money-market mutual funds, whose demise could have deepened the credit crisis beyond what we've seen to date. The beneficiaries of those aid programs underpin a financial system whose functioning is key to the overall economy.

For example, many consumers won't be able to buy cars if they can't access loans, and that lack of credit hurts auto makers who need buyers.

With Tuesday's consumer-oriented bailout moves, "there has been a tidal shift," Hogan said. "As for the complaints that Washington has been only helping Wall Street, that's not the case today. Washington is helping out Main Street."

Q: So if the government is helping banks and Wall Street, and now adding consumers, why hasn't it helped the auto industry yet?

A: Unfreezing credit markets is expected to help Detroit, but many of its troubles involve more fundamental issues about how the auto industry operates, and whether it's supplying the vehicles consumers want. So the fixes that Congress is considering are more than just a matter of figuring out how much money to provide.

"Some of the auto industry's problems are tied to credit markets, but some are much more structural," said Gus Faucher, director of macroeconomics at Moody's Economy.com. "There is no obvious answer."

[Associated Press; By MARK JEWELL]

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