Why Is Everyone So Desperate to Spend $700Bn?

United States Treasury Secretary Henry Paulson and Federal Reserve chief Ben Bernanke have spent much of this week in Washington on Capitol Hill warning Congress of the dire consequences that will follow if legislators don't approve a package to rescue the financial system.

What's most interesting to me is that the firestorm of objections this plan has raised is coming from both ends--and in many cases the extreme ends--of the political spectrum. Fortunately, most lawmakers appear intent on extracting concessions that give them some oversight and control, or perhaps fulfil policy goals they believe should be concurrently addressed. At this moment anyway, it still seems likely that a package of some sort will be approved albeit not as quickly as we initially thought.

Saying No and Meaning It
Still, there are other American voices suggesting that the entire proposition of a $700 billion bailout is simply another rich-get-richer scheme that has nothing to do with the proverbial "average Joe." Others view it as a devilish example of government overstepping its bounds and unnecessarily mucking around with the free-market system. Voices on both sides have suggested that it would be a very legitimate choice to simply do nothing at all.

The truth is that there are very few people who have a full and clear picture of exactly what the system's problems are, what their true scope is, what it would take to fix them, and what would happen if the government doesn't step in. Policymakers at the Treasury and Fed certainly have much more information than most, but there are still many things about the crisis that are at this point unknowable.

You Only Think about Your Plumbing When It Stops Working
There is one thing that's beyond debate, however, and that is the reliance of the global financial system on the constant flow and availability of capital. It has been repeated so often that I don't know who first coined the analogy, but the facilitation of credit, in particular, is often described as the plumbing of our economy. There's no need to take the analogy too much further, but we all know what happens when plumbing gets backed up, and it's never pretty.

That may seem strange to those of us not actively engaged in the financial sector, or the financial workings of the companies we work for. The fact is, however, that almost everything that goes on in the financial community has the potential to affect the so-called "real economy" that may seemingly live apart from financial centres such as London's Square Mile or New York's Wall Street.

Even businesses that seem fairly remote from the entanglements of the financial industry ultimately rely on it often enough. In some cases that's simply a matter of using the system to help sell long-term debt, and for such companies the day-to-day machinations of short-term credit are less of an issue. For so many others, however, the ability to secure credit lines, issue commercial paper, and the ability to take out loans is critical to their daily conduct of business. That really just scratches the surface, as there is such a vast array of additional tools and functions that businesses depend on.

Anyone who has purchased or sold a home, taken out a car loan, used a credit card--or relied on the services of a company in the aforementioned camp--has some relationship to the credit markets, as well. And it's a rare case in which the companies providing those services aren't somehow relying on others to help facilitate their operations with the movement of credit in one way or another. They usually themselves engage in short-term borrowing to fund loans that they make, and often those mortgages, car loans, and credit-card receivables are packaged and sold either as securities or in big blocks to other institutions.

How Much is Your Castle Worth?
The rescues of Fannie Mae and Freddie Mac in America were critical in helping to make sure that the core institutions of mortgage lending in that market remained intact. Yet, the constriction of available credit to homebuyers has already played a serious role in damping the American housing market, as in the UK, and continues to do so. Sustaining housing prices at current levels (assuming that those are reasonable, which may itself not be) depends on the existence of new buyers, and their collective ability to fund home purchases.

Some of us may live in areas not yet hard hit by the crisis. But if the availability of mortgage financing continues to deteriorate, thereby removing more potential buyers from the marketplace, there will be little to stop home prices all around a national market from continuing to fall. Whatever you may think your house is "really" worth--even if you quietly believe it's less than at its peak--your ability to unlock that value will always depend on the willingness of other parties to either cough up cash, or get access to borrowed funds. If that's in question, so is the "value" of your home.

What's the Worst That Could Happen?
The chief reason for today's rescue-package hand-wringing is that so many financial companies have found themselves holding mortgage loans, in particular, that can't be easily unloaded, and the prices of which are depressed or falling as well. Whatever the root causes, that situation has already proved painful for some, dire for others, and fatal for at least a few, including Lehman Brothers.

Even under the best of circumstances, those with risky assets who have thus far managed to survive won't be able to continue greasing the wheels of our "real" economy if those loans remain illiquid and stuck on their balance sheets. If they can't move them, then they can't use the capital they represent to make new loans. If the loans continue to fall in value and nobody steps in to stop or slow the deterioration, the prospect of a domino effect in terms of failing institutions becomes a very real possibility.

The Only Thing We Have to Fear Is Fear Itself...
In case it's not clear, the provision of $700 billion to detox the American financial system isn't itself necessarily the true solution to the problem. If housing prices were to suddenly stabilize, and actors in the financial system were to regain faith in each other, one could argue that the ultimate consequences of this mess would be kept from getting much worse. Unfortunately, there's no indication that either of those things are likely to happen anytime soon. Right now, the market is desperate for reassurance and some signs of stability. Whether that comes in the form of a $700 billion purchase of securities, or some other confidence-building rescue package, it needs to come and it needs to come soon. Could the U.S. financial system and the health of the American economy survive without it? The chances, unfortunately, are slim.