AP Photo/David Kohl
Procter & Gamble Co. chief
executive A.G. Lafley

Why Some Business Leaders Support the Bailout

October 01, 2008 06:36 PM
by Anne Szustek
Prominent business leaders are speaking out to why the bailout bill is important—and how it affects consumers as a whole.

Liquidity Makes the Economy Go Round

In Wednesday’s edition of the Cincinnati Enquirer, A.G. Lafley, CEO of consumer goods company Procter and Gamble, outlined what can happen when a company has no access to liquidity. “Mid-sized and smaller suppliers” of the company “are having great difficulty obtaining loans, capital guarantees and access to financial markets to take advantage of new opportunities to supply P&G,” he wrote in an editorial supporting the bailout bill.

The same concept applies on a greater scale, however, as Lafley also points out: “Small and medium-sized companies…whose normal access to credit is frozen, are finding it very difficult to meet their financial obligations.”

Investment guru and Berkshire Hathaway CEO Warren Buffett in a Wednesday interview on CNBC likened the current credit crunch to an “economic Pearl Harbor,” emphasizing the importance of credit to sustaining the economy. "When credit is as frozen as it has been and when banks are unwilling to lend to each other, and when 8 percent of deposits in American banks have had to be moved in the last couple of weeks to solvent institutions…the only entity in the world that can leverage up to match that force is the U.S. Treasury.”

Furthermore, when trepidation over the U.S. financial sector rises—the world’s economy goes into shock mode—as was the case in Pacific Rim markets on Tuesday following the U.S. House of Representatives’ initial rejection of the bailout bill.

Such was the reasoning behind the bailout bill endorsement from Business Roundtable, an association of 160 CEOs of companies with combined annual revenue of $4.5 trillion and accounting for nearly one-third of the U.S. stock markets’ capitalization. In a statement, John Castellani, the organization’s president, said the bill “will help stabilize the domestic and international economies.”
But how, exactly, would the bailout bill accomplish this? The answer lies in the details.

Background: The $700 billion bailout bill

In light of extreme Wall Street volatility in early September, marked most notably by mortgage companies Fannie Mae and Freddie Mac coming under U.S. conservatorship, longstanding investment bank Lehman Brothers’ bankruptcy and injecting flailing insurer AIG with $85 billion in liquidity, Treasury Secretary Henry Paulson unveiled a plan to buy up $700 billion of securities backed by illiquid mortgage debt.

The bailout bill, now known widely as the “financial rescue package,” would give Treasury Secretary Henry Paulson the right to buy up “residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages. A supplement from the Treasury expanded this to encompass “other assets, as deemed necessary to effectively stabilize financial markets.” Should the proposal go through, Paulson will have to report to Congress three months from the date the ruling becomes effective, then every six months from that date forward.

The proposal is meant to inject liquidity into the mortgage markets to ensure that banks have greater access to funds for lending. This means that should consumers need loans, lenders could afford to lend to persons who have anything less than a perfect credit score—and are thus considered to have some sort of risk.

Banks have traditionally relied on securities markets to purchase bundles of mortgages from them, freeing funds up to make further loans.

But with securities markets frozen, banks are unable to resell mortgages, and thus have no money to make further loans.

Most borrowers today, regardless of their financial condition or credit history, are having great difficulty obtaining the financing needed to operate their businesses.

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