I’m no financial guru and certainly don’t understand a lot of what could happen in Wall Street if the bailout does/doesn’t pass, but since I’ve been following this pretty closely of late, I figured I’d share what I’ve found and what I think of it all.

How We Got Here

Although it may not really affect what we and our lawmakers should be doing now, we absolutely need to consider how we got into this mess so we can avoid it in the future.  We also must be careful that, in our rush to do something, we don’t end up worsening or prolonging the underlying cause of the current credit crisis.  As usual, Ron Paul has some good comments regarding the causes, and makes a good argument for why no bailout is likely the best course of action in the long run.

At the heart of the current situation are the mortgage problems that have been surfacing for the past several months.  My dad sent me this cartoon, which effectively conveys the sequence of events which led to this.  Essentially, poor regulation from the government, corrupt and/or incompetent management of banks and lenders including Fannie May and Freddie Mac, and basic short-sightedness all around allowed lenders to approve loans for people who under “normal” circumstances would never have been able to get one.  The apparent lack of any significant consequences for this foolishness allowed it to continue and spread unabetted.

A few weeks ago these years of accumulating bad debt finally hit critical mass as the market and banks all over realized just how worthless the holdings of these banks had become.  Although the fundamental problems had existed long before September, 2008, the catalyst for the collapse was in many ways the bankrupcy of Lehman Brothers.  As investors recognized that Lehman’s heavy investment in subprime mortgages was at the heart of its decline, they evaluated other firms in light of this.  AIG was the next to fail as investors fled banks with large subprime holdings.  By the time analysts and government regulators truly clued into how low investors’ confidence had fallen, WaMu became the next victim in the sell-off.  Wachovia’s subsequent collapse was just icing on the cake as credit had frozen due to banks’ unwillingness to take on any more debt and it became virtually impossible for corporations and individuals alike to be approved for new lines of credit, and existing lines were tightened.

What The Credit Crisis Means Now

Although other markets may be fundamentally sound despite the failure of the banks, businesses in all markets rely upon credit from the financial sector for everything from new investment capital to meeting basic needs such as payrolls.  Although not all use managed debt for day-to-day expenses, enough do that a prolonged freeze on credit could have severe ramifications for main street as companies find themselves unable to pay their employees or continue to fund other operations.

Additionally, if investors continue to flee the financial sector out of fear of further collapse, remaining firms such as JPMorgan Chase, Wells Fargo and Citigroup may too find themselves on the brink of collapse despite relatively strong fundamentals.  Were this to happen, the country would face a situation similar to the Great Depression where banking is essentially shut down and credit unachievable.  Eventually, new firms would undoubtedly rise from the ashes to meet this demand for credit, but it would take time and the damage from such a complete collapse would have consequences for decades.

Whether this will happen without a bailout is unknown.  However, the possibility has struck fear in the hearts of financial analysts, investors and government regulators.  While there is no guarantee that a government purchase of these subprime mortgages will inject enough confidence into the market and banking firms, many believe it will forestall further exodus from the financial sectors and allow the remaining firms to start lending again, albeit not to the extent of recent years (a good thing).  Although few analysts believe the bailout will improve the current situation significantly, many find it to be our best way to prevent further sell-off and its consequences.

There is certainly an argument – and I agree with it – that it should not be taxpayers’ responsibility to bail out these banks who are responsible for the mess they’re in.  This is true, and in most cases the best solution would be to let the firms go bankrupt and wait for others to fill the gap.  The primary difference is how much other markets rely upon the financial sector and the domino-effect that rapidly-eroding investor confidence has had in the past weeks.  A complete collapse of this industry is something the market may not be able to recover from for many years.  The bailout is not guaranteed to work, and it’s certainly possible that enough banks would survive without the bailout that the doomsday scenario wouldn’t happen anyway.  But whether this is a risk we’re willing to take is something lawmakers and their constituents need to seriously consider.

I’m a big fan of Yahoo! Finance’s Tech Ticker video commentary and they’ve had some really good clips recently which discuss this issue from both sides.  I can’t speak to the likelihood of whether the bailout is necessary to forstall a nearly complete collapse in the financial sector, but there are definitely intelligent and experienced analysts and CEOs who take both positions.

Personally, I’m willing to stay on the fence and see what happens.  I won’t be writing my Congressmen in favor of either course of action.  If a deep recession is what this nation needs to realize the importance of spending within its means, then maybe that’s better than using taxpayer money to plug the holes in a still-deflating bubble whose collapse is the result of a long-needed market correction for the excesses of banks and individuals who let greed and ignorance fuel financially ruinous decisions.