A layman's guide to the financial bailout plan

As lawmakers hammer out a $700 billion deal aimed at reviving the nation's financial system, many Americans feel more than a little bewildered by it all.

We asked three economists — John Connaughton of the University of North Carolina at Charlotte, Todd Cherry of Appalachian State University and Michael Walden of North Carolina State University — to help us understand the basics.

What is the problem?

The nation's banking system is freezing up, clogged by billions of dollars of bonds secured by bad mortgages. Two banks, Merrill Lynch and Bear Stearns, were forced into sales. Lehman Brothers went bust. Other banks, unsure of who might be the next to go, are afraid to lend to one another.

Such paralysis on Wall Street has led to a credit crisis in which companies find it expensive or impossible to borrow and individual borrowers have trouble getting mortgage loans.

Investors, worried about the security of their investments, have pulled out of stocks and switched into cash or Treasury bonds.

How did this happen?

Low interest rates and loose lending practices over several years inflated the real estate market to heights that could not be sustained. The situation was worsened by speculators "flipping" real estate for a fast profit.

Meanwhile, banks were bundling mortgages together as securitized assets.

When interest rates rose, payments on adjustable rate mortgages became unaffordable for many homeowners, leading to record numbers of foreclosures and the threat of many more to come.

The bundled mortgages became toxic debt on the books of banks.

Stock market investors, unsure of the extent of the problem, pulled out. The flow of money slowed, creating a credit crunch.

What is the threat?

Economists say the current financial crisis could lead to widespread bank failures, further losses in home values, business closings and massive layoffs.

What does the federal government want to do?

President Bush wants to implement a series of rescue measures devised by Treasury Secretary Henry Paulson.

Paulson plans to use $700 billion of taxpayers' money for two years to purchase the distressed bonds, which would be put into a federally-backed fund controlled by the Treasury.

The hope is that once the market recovers, the fund would sell the bonds back into the market, recouping some of the $700 billion.

Why the objections?

In addition to the tremendous cost, many Americans are angered at the idea of bailing out Wall Street bankers who created the distressed bonds and who made huge profits.

There are also fears that taxes will have to rise to pay for the rescue and that $700 billion is not enough to restore confidence in the financial system.

Many lawmakers are concerned the bailout might set a precedent, with other industries turning to the government for help.

How would the bailout plan work? Would it extend to community banks?

Congress is working out the details, but Paulson is likely to get broad powers over the rescue fund.

Walden said the bailout could extend to all financial institutions, but the vast majority of assistance will undoubtedly go to the mega-banks and lending institutions.

Will homeowners facing foreclosure get a break?

Maybe. Some legislators are pushing for such measures.

What happens next?

Legislation must be approved by the House and Senate and signed by President Bush. In return for their support, Democrats, who control both houses of Congress, want more oversight, limits on executive pay and more assistance for homeowners struggling with mortgages. Republican lawmakers objecting to the plan mainly cite its high price tag.

Negotiations in Washington continued Friday as investors kept close watch.

Is there a precedent for this bailout?

Yes. Economists cite the Resolution Trust Corporation, which was a U.S. government-owned asset management company charged with liquidating assets (including mortgage loans) that had been assets of savings and loan associations declared insolvent by the Office of Thrift Supervision as a result of the savings and loan crisis of the 1980s.

Between 1989 and 1995, the Resolution Trust Corporation closed or otherwise resolved 747 thrifs with total assets of $394 billion.

What can you do to protect yourself?

Review your situation to determine if you should even be in the market.

"If you're close to retirement, your incentive to get out of the market is much stronger," Walden said.

Review your accounts at banks and other financial institutions to make sure they are fully insured.

Review how your 401(k) money is being invested and make necessary adjustments.

"If you're young, it's less of an issue because the markets will hopefully stabilize and come back," Cherry said.

"If you're nearing retirement and your 401(k) has dropped 20 percent, it's frightening. "I know people who are postponing retirement."