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Sunday, 21 September 2008

Reasons why the bailout might not work

Courtesy of CNA forummer: Johnlaw

The aim is two-fold. The government hopes that by buying these mortgages, enough debt will be removed from the balance sheets of banks to enable them to recapitalise and resume lending, something they have all but ceased doing since the subprime housing market collapsed. This, hopefully, will stem the precipitous drop in property prices, which has resulted in more and more homeowners defaulting on their mortgages. Secondly, the government hopes to sell these mortgages once the market recovers. If housing prices do cease falling and people resume buying homes, then the US stands to make a substantial profit from the mortgages it now holds.

But the US economy’s woes are not limited to merely falling home prices caused by a stagnant lending market. Nor will the removal of these bad debts guarantee that banks will become profitable again. Unless banks are able to return to their core business and resume lending, they will continue to fail, this bailout will be unsuccessful, and investors will resume their flight. Were that to happen the US economy will decline at an even swifter rate than we witnessed over the past week.

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