The Stimulus Package explained by an MBA to a 3rd Grader
Nov 13th, 2009 | By JJ Kennedy | Category: Fun and Rants, Lifestyle
It’s kind of a point of pride for me that I am pretty good at taking complicated topics and breaking them down so everybody can understand them. So when I started looking at the stimulus package, I imagined having a conversation with a 10 y.o. about it. How would I explain it and what questions would they ask?
So here’s the imaginary conversation with Timmy, a smart 10 year old 3rd grader with blue freckles. I know. I’m weird.
What is the stimulus package?
It’s a way for the government to inject money to help turn around a crappy economy. It does this by creating jobs, saving jobs, and ultimately getting people spending money again on things like cars, houses, investments, and Xbox’s.
Why do we need it?
- Right now lots of people are out of work or don’t have enough work to pay their bills.
- Because of that, they (consumers) can’t spend money buying stuff, investing, saving, or paying taxes.
- Because consumers can’t buy stuff, businesses are not selling as much as they need to make a profit.
- Because businesses aren’t making their profit, they are firing even more people. See point 1.
- In addition, because people are not buying investments combined with business not making as much profits, that means the stock market is going down because the business stocks are not worth as much as the used to be.
- When the stock market goes down, people lose money they had in there, can’t buy stuff, and stay away from putting any more money back in the stock market for a long time. On the business side, companies now don’t have the money it usually makes from selling stocks to invest in creating new stuff. Back to point 1 again.
How is the stimulus package supposed to fix it?
Create New Jobs -
What it means? More people working, more people paying taxes, more people buying stuff, which in turn means businesses hire more people to make more stuff, on and on. Upward Spiral.
How fast will it work? 1-5 years. Since most a lot of the spending is for infrastructure or big construction projects, it will be a while for that to trickle down. You don’t start a massive development project in a few weeks or even months. The upside is that these projects have a much greater return on investment over the long term. Lots of jobs for a long time to come. Just takes a little while to get started.
Save Existing Jobs-
What it means? State and Local governments are bumming. Because less people have jobs and spend less, states get less in taxes. Less in taxes mean that they have to cut programs and personnel. Less personell, more unemployment. Downward spiral.
How fast will it work? Immediate. These are existing jobs doing existing things. They can hire you back tomorrow if the government gives the local states and cities the funds. In addition, the workers will be then paying taxes on their income and buying more stuff. That’s helps everybody.
Provide Tax Relief
What it means? If you have more money in your pocket because you are paying less in taxes, you will spend more.
How fast will it work? Immediate to 1 year. This depends on what type of tax cuts they are. If they are employer tax cuts, you will see a difference in your paycheck right away. If they are credits or rebates on your year end taxes, you will not see any difference until you go to pay your taxes in 2010.
Another tough question as part of the tax relief – Will $20 more a week in your paycheck really do anything to increase your spending or consumer confidence? Will you even notice it? Also, I have a feeling that most people are not going to run out and buy a new big screen when they get their tax return next year. My guess is that they are going to use it to pay off their credit card debt, student loans, car payments, or mortgage balances they have been slacking on for the last year.
Making a better tomorrow
What it means? Many of the provisions in the stimulus package are towards energy independence, smart electricity grids, and education. These projects will also create a lot of jobs.
How fast will it work? 5-10 years minimum. These investment should all pay off handsomely, but they will take a long time. Energy independence and efficiency will eventually ease our reliance on outside energy and keep prices manageable (or at least insure that we buy from ourselves not foreign countries) Funding for education in theory will ensure that US keeps more jobs, increase US innovation, improve employment rate, and boost our GDP.
Helping those who are struggling
The last section of the stimulus package is to help out those in need. It’s a band-aid. Because so many people are unemployed right now, the y will be subsidizing health insurance and extending unemployment benefits.
How fast will it work? Immediately.
What caused the recession to start with?
To over-simplify: Greed and easy money. Banks lent money too easily in hopes of bigger profits, people spent too much on credit on stuff they really couldn’t afford, and business and people alike made risky investments in hopes of bigger profits.
For a while banks were lending 95 to 100% loans. That means if you stop making payments, they take your asset (the thing you bought with the loan). If your asset loses any value (think housing market crash) then the banks are stuck owning something that is not worth as much money as you paid for it. Because they are stuck with this crap asset, they don’t have cash on hand to loan more money to other people. If the bank can’t make loans, they can’t make profits themselves (the interest they charge you for loan). End result – bank fail.
Now combine that with people losing their jobs and shaky consumer confidence. As a result, consumers are not buying as many things that require a loan, and are not sticking money in the bank (which the bank then turns around and loans to other people) Vicious downward spiral.
Do other countries have stimulus packages?
Yup. China has its own stimulus packages that it unveiled last December. China said it would spend an estimated $586 billion over the next two years to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May. As a percentage of Gross Domestic Product (how much money the entire country makes on stuff that it creates), Chinas bailout is actually bigger than ours.
Have we ever needed a stimulus package or were times this bad before?
Yup. Several Times.
Most notably the Great Depression, which lasted from about 1929 to the early 1940’s. But there have been several other ones which were lot smaller and shorter.
Has a stimulus package worked before?
Yup. But what really helped wasn’t designed as a stimulus package exactly.
Most economists say that the HUGE government investment in WWII is what finally pulled us out of the great depression.
Franklin Delano Roosevelt enacted a series of programs called the New Deal from about 1933-1939, and it started a slow upward tick from 1933 (when it was at rock bottom with 25% unemployment). But it was really when we committed to WWII and basically said, damn the price, we need these military supplies NOW that the country got to work building them.
Because of the government spending on WWII we had a simply HUGE national deficit (10 times worse than it is now) as compared to our GDP. But, within about 4 years (between 1946 at its worst and 1950 at its best) not only was the deficit pulled out of the negative, but we actually had a surplus for one of the few times in US history. Thanks in large part to all these new business now paying taxes on all the money they made, people paying taxes on the income they made from these businesses, and people now buying stuff with improved consumer confidence and all the money they made.
Where is the money for the stimulus package going to come from?
That’s an excellent question. For 31 of the last 35 years, we have run a federal deficit. That means that the government takes in less than it spends. That’s like you having $5000 in bills a month and only making $3000 a month.
That is not the same as the federal debt. The federal debt is money the government owes to its taxpayers or other countries. That’s like a credit card. You buy something now on credit and promise to pay it back later plus some additional fees for interest. Debt by itself is not necessarily a bad thing. But it IS a bad thing when you are running a deficit and have no real ways of fixing that deficit anytime soon. To help fund your deficit you take on more debt, when further increases your deficit. Get it?
Now, how are we going to pay to dump this $800 billion into the economy when we already have $10.7 Trillion in debt, and still have a federal deficit of about $500 billion?
Option 1: We will get about 50% of the money from our Treasury selling securities to US consumers, businesses, and banks. The Treasury will sell T-Bills and bonds to us in exchange for an interest payment. They usually pay pretty crappy interest rates, but when the stock market is in such turmoil, a lot of people invest in them because they are very secure (The only time you will ever lose money on a Treasury Security is if the entire government crumbles, and if that is the case you got a LOT bigger problems than losing your money).
Demand for these securities will determine how much interest the Treasury has to pay to get buyers.
Option 2: We borrow money from other countries. That usually makes up about 30% percent of our debt (China is the big buyer these days)
Option 3: We still have about 20% of the funding to be taken care of. Where is that going to come from? Looks like nobody knows. Reassuring hunh?
What are the dangers of taking on this debt?
There are lots and lots. A few important ones tho…
Scenario 1: The demand for the Treasury Securities is really low. That means the Treasury has to offer really high interest rates to get people to buy them. This could cause 2 problems. First, banks have a limited amount of cash to invest. If it is more attractive for them to use peoples savings to buy Treasury Securities, than it is for them to loan money to people…they will buy the securities. That would have the opposite effect of helping the economy and would actually make things worse.
Scenario 2: Our big debt buyers like China are struggling too. They may not want to invest in our debt if they are having their own issues.
Scenario 3: If Americans don’t buy the debt, eventually other countries will step in. Can you anticipate what the problem would be if China or another country holds the majority of our debt? What if China decides it wants to become a bully? Imagine you mom lets the meanest bully at school hold everything you own…your bike, your lunch money, your toys? And the only way you can get them is if he says it is ok. That’s kind of what we are talking about here.
Could this really be another Great Depression?
It’s a real possibility. Not too many people are talking about it yet, but the similarities to the Great Depression are pretty scary.
Most people think the Great Depression started from a few things…
Similarity 1:
Greed: An overindulgence on the part of consumers and the banks. After WWI, businesses had a surplus of inventories and introduced the idea of credit to help sell what they had. Because people were feeling pretty confident after winning the war, they went crazy buying stuff on credit. It was an decade of getting rich and enjoying new fads. Credit made it possible to buy what you couldn’t really afford.
Similarity 2:
Stock Market Crash of 1929: In the early 1920’s, because of the consumer confidence and huge amounts of money coming into businesses, it caused the first stock market bubble in the 10 years before the crash. Stock prices where unrealistically overinflated compared to their true value. Kind of like they have been for the last 10 years for us.
Then in 1928 or so because of the credit debt built up and other factors, consumer confidence was shaken and then finally failed. In October of 1929 on “Black Tuesday” the market suffered its biggest loss of $15 Billion in a single day (Think how much $15 Billion was in 1929 when a new car cost $250). A month later, the stock market had lost ALL of the gains it had made in the previous 2 years.
Similarity 3:
Bank Failure: Prior to the Great Depression, banks had made many loans to people, businesses, and other countries paying off THEIR war debts. They were also heavily invested in the stock market. As the recession took hold in the few years leading up to the great depression, more and more people defaulted on their loans, the stock market crashed and banks were in a position that they didn’t have the money on hand to allow people like you and me to withdraw funds from out own accounts. This caused a further panic which made EVERYBODY rush to the bank to take their money out only adding fuel to the fire. End result: Bank fail.
Is the Stimulus Package Going to Work?
I think so. I hope so.
The similarities to the Great Depression and its causes are just too striking to believe that this well be over soon. But, I think we have a chance of getting out of it without going through something as severe as the Great Depression. Here’s Why:
Reason 1: The New Deal that Roosevelt enacted was very similar to the stimulus package we are talking about now BUT didn’t include nearly as much big spending. It showed some real signs of progress, but ultimately the huge investment in WWII pulled us out.
The new stimulus package has the big ticket spending built in from the get-go.
Reason 2: There is a lot of faith and confidence in Barak Obama. Since consumer confidence plays a huge role in a depression, having a trusted authority figure communicating with people on a frequent basis in a clear, honest way will really help.
Reason 3: Hopefully we have learned a little from our years on the planet and the mistakes we have made in the past. I think we forgot about them for a while. A good slap in the head is always a useful reminder.
That’s it. Hoped this helped Timmy (and all of you). Let’s go play Xbox.
If you liked this article, and think it might be of help to anyone, please pass it on. Better yet, tell them to check out the EvilGeniusTV blog. I say other smart stuff once in a while.
As always please comment/critique/argue/flirt/yell/question below. Don’t matter what it is.
JJ
References used in this article: LOL. You ready for this?
Stimulus Package Unveiled – WSJ.com
America’s Great Depression – Causes and Cures
BEA News Release U.S. International Trade in Goods and Services
Federal Budget Spending and the National Debt
GDP Current Statistics – A Summary of Current US GDP Statistics
Great Depression – Wikipedia, the free encyclopedia
Gross domestic product – Wikipedia, the free encyclopedia
Just who owns the U.S. national debt – Answer desk- msnbc.com
News Analysis – Components of Stimulus Vary in Speed and Efficiency – NYTimes.com
The National Budget, Debt & Deficit MarkTAW.com
When Stock Prices Go Down, Where Does the Money Go
New Deal – Wikipedia, the free encyclopedia
Great Depression in the United States – MSN Encarta
China Unveils Sweeping Plan for Economy – NYTimes.com
Who Will Fund Obama’s Stimulus Spending
Digging Deeper Into Bull And Bear Markets
Economic Stimulus Package Where does the money come from
I’ve been reading along for a while now. I just wanted to drop you a comment to say keep up the good work.
Thanks. I appreaciate it
Umm…FDR did the New Deal, not Teddy. Teddy walked softly and shot a bunch of animals
Whoops. Thanks for the heads up. Must have been some bizarre fetish I have with stuffed animals that screwed me up. I’ll fix it
[...] One spent 3 days researching and writing a well thought out explanation of the Stimulus Package in everyday language which got half the page views of this picture which took 10 minutes in Photoshop… totally ok [...]
I didn’t want my only comment to be about the minor Roosevelt oversite. So,
I’m really glad that you included the section about where the money comes from. I get tired of hearing Republicans bitch about saddling our great-great-great-great-great-not-so-great-great grandchildren with debt, without actually explaining what that means. Almost as tired as I am of hearing Democrats talk about spending money like we have loads of it stockpiled in a huge piggy bank somewhere that we were saving for a vacation to an unnamed exotic locale, but will use it to bail out banks instead. And, I’m sick to puking of hearing both parties bitch about the lack of bipatisanship.
Sidenote: There is FINALLY a version of the stim pack available on the white house homepage. None on the DNC or GOP pages though. It bothered me greatly that during all of the debates about this package, there was no info readily available about it on any of the afore mentioned websites. How am I supposed to call my congressperson and give my yea or nea if I have no idea what I would be yea or nea-ing? Especially after all the blab about “transparency”.
Anyway, good work here brotha.
Thanks. I appreciate it. I’m a big fan of Obama (or at least what he appears to represent, and how he leans towards communicating over dictating) but I am a little bit disappointed with the transparency thing too. I know he is trying to roll things through fast, but its pretty tough to put all the pieces together and explain what it really means. Would have been nice for them to put together something like I did. I certainly hope they are better at it than me
Thank you for taking the time to explain it in full detail with clarity.
I’m a great fan of Obama and will be patient while he learns the ropes. He is trying his best and that’s better than what we’ve had over the years.
Once again, thanks for the breakdown!!
Well done to a point. It’s obvious that you’re a big fan of Obama and I hope the best for him, though I’m not a fan. I’m not patient while he learns the ropes because he should already be familiar with them when he got the job, but we know this to be false. I’m also thinking that if this package, which is full of pay offs to the people/groups that supported his campaign and not full of stimulation, is his best, we’re in serious trouble for at least the next four years. Of course, part of my feelings exist because I’m a capitalist not a socialist like our president and the congressional leaders.
This is easily the largest bill ever put before congress to nationalize our businesses and entire industries. And while greed was certainly a part of the loan situation, this package smacks of greedy power by Pelosi and Reed. It is astonishing that anyone with any business or economic knowledge would think that this is even a marginally good bill/idea. Thus, it isn’t better than what we’ve had over the years.
And, in fact, things were worse in 1980 at the end of President Carter’s tenure than they are now with the prime lending rate at 21% and unemployment as high as 8 1/2%. It’s simply bad judgment.
However, I think you explained it fairly well in simple and very general terms without any detailed explanation of how any of this will really impact our culture and society in the immediate future or in perpetuity.
Thanks for the effort and research.
Thank you for your comment DJ. Love bringing up politics b/c lots of people have different viewpoints and its nearly impossible to tell which is right until about 20 years after the fact.
I like Obama because he represents something different. (if he acutally is or not remains to be seen) He is a communicator and diplomat more than he is a fighter. And I value that.
It’s kind of how I roll. I’ll talk to you first and try to find a common ground. THEN if you are still a dick, I will kick you in the balls with such overwhelming force that fighting back is no longer an option.
I personally believe the stimulus package will work becuase of Obama, not the package itself. Here is why: Obama will go out of his way to communicate with people. At least more so than anybody has in the last 8 years. Whenever you are rolling the dice, if you communicate with people what you are doing, why you think it will work, and what might not work… people feel a lot more comfortable with what you are doing.
People feeling in the loop on what is going on will really help with consumer confidence, wether the stimulus really works or not.
And ultimately consumer confidence, not the banks, not taxes, not the deficit, is what pulls out of a recession.
If you agree of not, I sincerely thank you for your well though out post.
JJ
Thanks for the article. Learned from it and I’m way past being in the 3rd grade. Pat
It won’t take 20 years to figure out that socialism doesn’t work. It may take a little while for dumber Americans to figure out that they can’t live off of their neighbors.
It’s all going to paid for by a small increase in taxes on the wealthiest Americans. Sure. Only people who make more than 200k will pay higher taxes. Sure.
The direction of the market is a bet about the future and a gauge of uncertainty, and most investors recognize that Obama’s plan to raise taxes in a recession, attempt to nationalize health care,and spend money we don’t have isn’t the right solution for the American economy. Investors may also be a little skeptical of a president who nominates a Treasury Secretary who asks for billions and then admits he really doesn’t have a plan.
Hi,
There are two things from your article that caught my attention. One is a way we can support the economy, and the other is a question.
These are the first four bullet points from the article:
1. Right now lots of people are out of work or don’t have enough work to pay their bills.
2. Because of that, they (consumers) can’t spend money buying stuff, investing, saving, or paying taxes.
3. Because consumers can’t buy stuff, businesses are not selling as much as they need to make a profit.
4. Because businesses aren’t making their profit, they are firing even more people. See point 1.
The thing that occurs to me is that we – all of us – support low paying, part-time jobs by shopping, specifically, at Wal-Mart.
My personal opinion of Wal-Mart is that they are doing precisely what a corporation in today’s market is supposed to do. They are maximizing profits, limiting liability and cutting expenses as much as possible.
This is what stockholders want because they want to put those maximized profits into their pockets.
So how does this lead to us supporting the economy?
Because it’s up to us, as consumers, to make a deliberate point of going to the smaller, more expensive, retailers in our neighbourhoods and paying those higher prices. You’re right, we can’t really afford it for all our purchases.
So, use Wal-Mart in just as calculated a fashion as Wal-Mart is using its resources. Make selected purchases at Wal-Mart with the objective of saving money that you can then spend with local small businesses.
The only power a corporation has is the money we give it.
I think Wal-Mart is a good corporation. They just aren’t a very good corporate citizen. But when you affix blame for how this particular child turned out, be sure to stand in front of a mirror and consider you spending and investing habits.
The other thing – the one that gave me a question – is the part about banks, loans and assets. Here it is:
“For a while banks were lending 95 to 100% loans. That means if you stop making payments, they take your asset (the thing you bought with the loan). If your asset loses any value (think housing market crash) then the banks are stuck owning something that is not worth as much money as you paid for it. Because they are stuck with this crap asset, they don’t have cash on hand to loan more money to other people. If the bank can’t make loans, they can’t make profits themselves (the interest they charge you for loan). End result – bank fail.”
Here’s how I understand the loan process:
I go to a bank to buy a house and want a loan. My credit rating is okay, and the bank agrees to loan me the money. Let’s say $100,000.
The bank isn’t loaning me the money depositors put into the bank. In fact, banks are specifically not allowed to loan the money I put into my chequing or savings account.
So, what they do is “invent” the $100,000 they are loaning me. They can do this because I have promised to make the $100,000 a reality by paying it to the bank. Plus interest, of course.
The interesting part is that the bank gets to add this loan to their list of assets. Because I promise to pay $100,000 – plus interest – the bank gets to claim an asset of the prinicipal plus the interest.
Just to use as an example, let’s say the interest on the loan – over the 20 year life of mortgage – is going to add up to $92,000.
(Just take the amount of your mortage principle – the amount you borrowed – and subtract it from your monthly payment for 20 years. Say $800 a month for 20 years. That’s $192,000 – so the interest is $92,000.)
So the bank is now claiming an asset of $192,000.
Only none of this money really exists yet. There is only my promise to make it exist by paying it to the bank. Everyone knows the bank manager does not walk into the vault to get me a pile of money.
Amazingly, currency – physical money you can hold in your hand – accounts for less than 10% of the money circulating in the economy. All the rest of the money is based on promises to pay.
Now back to me. Two years after getting the mortgage, I default on the loan. What, exactly, has the bank lost?
In two years, I’ve paid $19,200 ($800 per month).
So the bank is really ahead of the game by almost $20,000. After all, they started with nothing and now I’ve given them a lot of moeny.
But that isn’t how it works. Instead, the bank gets to claim a loss of $172,800 because I failed in my promise to pay. They get to claim is as a loss, and use it as a tax write-off, even though all they really lost is anticipated income.
Plus, they get to keep the asset. They keep the house and the property.
So my question is, first, do I have a correct understanding of the process? And then, if I do, why are we in such a turmoil over losing something that never existed in the first place?
I do apologise for taking up so much space. I’m just wondering how much of this crisis has been manufactured. I keep thinking back to Y2K and the volume of sales generated by scare-mongering.
How can money that never existed cause so much trouble?
Conrad
Conrad,
Nice comment. Don’t ever worry about taking up too much space
And in answer to your question:
Here is my understanding about the morgtgage process. I am by no means and expert and may be completely wrong. I’m gonna try to give a call to one of my old bank buddies and see if he can enlighten me further.
But anyway,
When a bank loans you money, it acutally IS the deposits of other folks. The fed mandates what percentage they can loan out (90-95% I think) But, keep in mind, it is the Fed NOT the bank that guarantees your deposits.
It gets a lot more complicated when we talk about them then bundling and selling your loans on the secondary market, but I won’t got into that…mostly becuase I’m not sure how it works.
So say you default on you loan after 2 years and paying around $20k. The vast majoriy of those payments to the bank is all interest that early in the life of the loan.
When a bank writes it off, they will write off $100k asset (big deduction), and a revenue stream (not so big deduction) of $72k ($92k-20) They are not treated the same in terms of taxes. They are still on the hook for that $100k they loaned out originally. Yes they now own the house that was the collatoral, but in this market, that is neither a liquid asset or one that is anywhere near the original value.
So, the $100k (or at least a big portion of it) wasn’t invented out of thin air. Somehow that money needs to be put back into the pool.
Where you do have the money “invented” is in “secondary assets” Following the same rules, lets say that the 100k loan now becomes a bank asset on their books. This is where I am not sure how it works… it is theoretically possible for them to now loan a 90-95 percentage of that new “asset” (which is based on 90-95% of the original deposit) If that is the case, what we really have is double dipping. I am sure at a minimum they can also claim the $20k you have paid in interest as an asset, but can’t claim the other $72k until you acutally have paid it. (Again unless they have sold it on the secondary market in which case they CAN claim both)
It would not surprise me if that is how it works, and would explain a LOT of the banking crisis.
No wonder the system is so f’d up
This stuff is CONFUSING!
I’ll see what I can do to get a real expert in here to discuss.
Again thanks for the comment.
JJ
Eric,
Thanks for the comment. I don’t particularly agree, but I like to have different viewpoints.
Can you elaborate on what you think should be done differently.
It’s one thing to say something sucks. It’s another entirely to say something sucks, and here’s what I would do instead.
Would love to see your sugguestions.
Regardless if I agree with them or not, I’m sure we have a lot of readers who disagree with me on lots of thing and would like a different perspective:)
[...] One spent 3 days researching and writing a well thought out explanation of the **Stimulus Package in everyday language which got half the page views of this picture which took 10 minutes in Photoshop… totally ok [...]
How do you explain to a 10 year old about hyper inflation being the hidden tax that is waiting down the road right when the economy starts to rev up again? How do you explain to them that 100 dollars will actually be worth $30 in a few years? How to you explain the fact that governments simply borrow money or print money when they don’t have it just to cover things like trillion dollar bailouts? How do you explain that borrowing money you don’t have and can’t pay back is foolish and that printing your own money to create wealth is illegal for you, but for the government it’s ok? How do you explain to them what economic slavery actually means?
Thats a really good point, and a really tough question to answer.
My advice to them would be to acutally learn your history as boring as it usually is. And keep that knowledge in your shirt pocket in the future.
In it we see that all of these things we are facing now, we have seen before. And all of the stupid things we did that caused this to start with, we have done before.
There really is no good rememdy for what is going on. We have never found one in the past, and I don’t think this one will be any different. It’s a stop gap to give the illusion that we are doing something productive about it.
If future generations can manage to remember what gets us in trouble in the first place, maybe they will not be reduced to short-term bandaid solutions that are a waste of time, energy, and money.
But given the years of documented history, failed attempts, and what should have been learned lessons, we continue to screw it up time and time again.
So tell them that. Be honest about our failures, and maybe someday, some generation will get it right BEFORE it happens.