Why Bail? The Banks Have a Gun Pointed at Their Head and Are Threatening to Pull the Trigger

If you have a real story, you don't have to make up phony stories. That's pretty straightforward.

I've heard lots of phony stories. Much of the country's political and economic leadership has been running around raising the prospect of the Great Depression and a breakdown in the banking system (I actually had taken the latter seriously). These stories are absolutely not true.

There is no plausible scenario under which the no bailout scenario gives us a Great Depression. There is a more plausible scenario (but highly unlikely) that the bailout will give us a Great Depression. There is no way that the failure to do a bailout will lead to more than a very brief failure of the financial system. We will not lose our modern system of payments.

At this point I cannot identify a single good reason to do the bailout.

The basic argument for the bailout is that the banks are filled with so much bad debt that the banks can't trust each other to repay loans. This creates a situation in which the system of payments breaks down. That would mean that we cannot use our ATMs or credit cards or cash checks.

That is a very frightening scenario, but this is not where things end. The Federal Reserve Board would surely step in and take over the major money center banks so that the system of payments would begin functioning again. The Fed was prepared to take over the major banks back in the 80s when bad debt to developing countries threatened to make them insolvent. It is inconceivable that it has not made similar preparations in the current crisis.

In other words, the worst case scenario is that we have an extremely scary day in which the markets freeze for a few hours. Then the Fed steps in and takes over the major banks. The system of payments continues to operate exactly as before, but the bank executives are out of their jobs and the bank shareholders have likely lost most of their money. In other words, the banks have a gun pointed to their heads and are threatening to pull the trigger unless we hand them $700 billion.

If we are not worried about this worst case scenario (to be clear, I wouldn't want to see it), then why should we do the bailout?

There has been a mountain of scare stories and misinformation circulated to push the bailout. Yes, banks have tightened credit. Yes, we are in a recession. But the problem is not a freeze up of the banking system. The problem is the collapse of an $8 trillion housing bubble. (It was remarkable how many so-called experts somehow could not see the housing bubble as it grew to ever more dangerous levels. It is even more remarkable that many of these experts still don't recognize the bubble even as its collapse sinks the economy and the financial system.) The decline in housing prices to date has already cost the economy $4 trillion to $5 trillion in housing equity. This would be expected to lead to a decline in annual consumption on the order of $160 billion to $300 billion.

Given the loss of housing equity, I have actually been surprised that the downturn has not been sharper. Homeowners had been consuming based on their home equity. Much of that equity has now disappeared with the collapse of the bubble. We would expect that their consumption would fall. We also would expect that banks would be reluctant to lend to people who no longer have any collateral.

This is the story of the downturn and of course the bailout does almost nothing to counter this drop in demand. At best, it will make capital available to some marginal lenders who would not otherwise receive loans. We should demand more for $700 billion.

For the record, the restrictions on executive pay and the commitment to give the taxpayers equity in banks in exchange for buying bad assets are jokes. These provisions are sops to provide cover. There are now written in ways to be binding. (And Congress knows how to write binding rules.)

Finally, the bailout absolutely can make things worse. We are going to be in a serious recession because of the collapse of the housing bubble. We will need effective stimulus measures to boost the economy and keep the recession from getting worse.

However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.

While their argument is wrong, these are powerful voices in national debates. If the bailout proves to be an obstacle to effective stimulus in future months and years, then the bailout could lead to exactly the sort of prolonged economic downturn that its proponents claim it is intended to prevent.

In short, the bailout rewards some of the richest people in the country for their incompetence. It provides little obvious economic benefit and could lead to long-term harm. That looks like a pretty bad deal.

Comments

[hu.man]

The so called bail out is heading toward another defeat. The powers-of-the-be have not convinced the public that this is more than just a handout for the rich. There is a great disconnect that is going on. The pundits on cable news are mostly asking for public to support this bill because they are told by the "experts" that we are otherwise facing economic calamity.

The truth is that most of these "experts" are vested in the stock market and are rushing to judgment to protect their own 10 acres at the expense of the rest of us. But the public is not buying it. Interspersed amongst these so-called experts, there are a few individuals like Dean Baker that have managed to put our collective interest ahead of their own individual desire to be rescued.

Those who perceive a calamity are indeed correct. They are only correct that in so far as the calamity is taking place in their own net worth and not the rest of us. The vested bourgeois is feeling pain and is trying to make believe that we are all in same boat. Nice call Dean.

[3arthling]

As we sleep, the Senate is planning and end-run around the House vote, and the House plans on "repackaging" the bailout to be introduced again as early as tomorrow.

Irrespective of where you personally stand on the bailout, your representatives need to know what you think. With nearly a trillion dollars on the line, if ever there was a time to contact your Congressman or Senators, this would be it.

Here is contact information for every member of Congress:
http://www.conservativeusa.org/mega-cong.htm

When writing, try to be respectful and not to be hyperbolic - that will just land your fax in the trash. Your rep is unlikely to actually read what you send, but someone who matters will.

[Grit]

What I saw was our government try to hand 700 billion to the very people that got us into this mess in the first place. There was no mention of getting rid of the people that ran these companies into the ground in the first place. There was only talk of limiting their compensation to only 1 million? Geez I went into the wrong business. Wouldn't it be great to get to destroy a corporation while raking off millions then get your future compensation limited to one million a year as punishment? Everyone is surprised that a bailout bill that basically sucked failed. It was even going to hand lord bush 100 billion to divvy out as he saw fit. Humm wonder where that would of gone. Just think how many roads and bridges could of been fixed, a new power grid, levies repaired and updated, peoples homes saved from foreclosure, medical research, people fed, storm damage and on and on. How much of a boon to the economy all this would of been. especially coupled with the cost of the Iraq occupation. BTW it hasn't been a war for a long time its an occupation. Of course there is no telling what else was in bill, as we weren't told but a few highlights.

[palindromedary]

Are the people in the streets responsible for the economic trouble we're in? That depends on whether you voted for Bush! If you voted for Bush then you deserve the risk you took....just like when you invest in risky stock. Clinton had a large surplus when he left office....Bush, and his supporters, were responsible for squandering that wealth while their upper echelon "cream of the crop" stole the wealth of the nation. Now that "cream of the crop" wants those who did not take big risks to bail them out. No way!

[Star2000dancer]

This is Bush theatrics. A plan to make McCain a hero, & to knock Obama. Let Wall Street take care of of Wall Street & watch the cream rise to the top. No bailout!!

[KillTheMessenger]

"Are the people in the streets responsible for the economic trouble we're in?"

Absolutely. Just look at all the home owners who are still trying to cash in big time on their homes. Prices are still inflated and inventory isn't moving because some prices are just outrageous. We need another 15-20% correction before we can talk about reasonable real estate prices.

Not to mention that a lot of today's problems were set in motion by the Reagan administration. Bush and the bankruptcy of the country is just the logical conclusion.

[bbbear]

Thank you for your nuggets of wisdom and I fully agree. But IMO congress, and not the Fed, needs to be ready to nationalize failing banks and commercial houses as this ugly house of cards, Ponzi scheme continues to fall. At the same time, congress needs to rebuild the structure upon the true integrity of Adam Smith/David Hume while using the steel of solid regulations and oversight.
In order for that to happen, congress must also wall out Big Money Lobby which is the glue holding the greedy, ugly Ponzi scheme together.
However, I strongly suspect none of that can happen until we have a new administration in the White House... and that administration cannot be of the same Reagan/neo con party represented by Bush, McCain and Palin.

[davidwayneosedach]

I think the bailout will 'eventually' go through. And that it will be less than 700 billion.

Unfortunately subsequent "bailouts" will total more than a trillion. And it will take a long recession before the market gets back on track.

[Slimsmom]

I am not an economic expert and I am sure that I don't understand the full ramifications of what is going on with the economy. I am just an average citizen who is outraged by all of the greed and corruption I see going on in the halls of government and Wall St. I, like many others, am sick to death of the upper echelons of our country getting special treatment at the tax payers' expense. The average citizen, Democrats and Republicans alike, see the avariciousness of the powers that be and say to ourselves that enough is enough.
Government, time and again over the last forty or so years, has bailed out financial institutions because of their inability to stem the flow of greed and corruption within their own walls.
How many of these "poor banks" lobbied to make it harder for insolvent average citizens to file bankruptcy?
For me, it doesn't matter what the ramifications to the nations economic situation will be. The party is over and all of us, from the top down, will just have to deal with whatever comes our way. The greed is good mantra is finally having its' false paradigm exposed for what it is. I say, it's about damn time.

[hu.man]

No need to believe the prophets of gloom and doom. Just sit tight. I may be the only person that I know of that does not believe any type of significant downturn in economy will take place. What do I base this on? We live in a global economy now. Everyone from South America, Europe, Asia will chip in to get us through. We have Brazil, India, China, the mighty EU, Japan, Taiwan, Korea, Australia, Canada and UAE to come in and fill in for the loss in economic activity here in U.S.

I do believe that the U.S. leadership role will be reduced. Currently U.S. is the single largest provider of liquidity to the global markets. That will change because the global banking system will realize that this type of dependence on a single provider is dangerous. At times like this, when massive contractions in liquidity take place in the U.S., the world's exposure to the U.S. banking system becomes apparent.

This will change and with it the U.S. influence which is as it should be. The global banking system is now sufficiently evolved to take care of its own.

[thriftyone]

Wikipedia records entries dated in 2007 about the US housing bubble with quotes from Greenspan and the Economist dating back to 2005! see http://en.wikipedia.org/wiki/Housing_bubble
Why is it this is not being reported on in the press? Why are we only hearing about how the very bad behavior of bankers and greedy wall street types is going to lead to a catastrophe of epic proportions if we do not bail them out of this crisis of their own making? The plan should not be to reward this behavior but to shore up those of us who are responsible, keep people in their homes and put the working class back to work.

How 'bout we try a few common sense approaches:
1) unbundle those securitized home loans
2) allow the banks to keep all performing loans on their balance sheets
3) force the banks to renegotiate all underperforming and where possible nonperforming loans. Keep people in their homes!
4) put together a jobs program. The country's infrastructure is crumbling. We need better roads, bridges, schools and hospitals. A person with a job pays taxes and can pay their bills (like their mortgage!). This is certainly a better place to use $700b than to line the pockets of the rich and infamous. Talk about stimulating the economy, certainly would do more than that previous stimulus package of giving $300 back to each taxpayer!

[wagadog]

Yah. I said from the beginning, the whole shaggy dog story we're getting reminds me of that National Lampoon cover -- "Buy our magazine, or we'll shoot this dog!"

Yeah, Yeah, Yeah.

(yawn!)

[billw8017]

The bailout seems misdirected. Institutions that lacked such foresight as to create bad debt should sink and disappear. if this makes problems, we should attack the problems directly. This approach would be most efficient or practical when done right.

Elsewhere, UNDELUDED writes, "If heads-of-households knew that their families would be protected, they'd be able to afford higher mortgage rates, new cars, etc." This would amount to an enduring "stimulus" program while it rationalized our broken healthcare coverage. Each little step would work in such a direction. For example, we could extend Veterans Administration coverage to all the ailments of veterans and to their families. While this allowed us to disband the bureaucracy that denies care to veterans and the legal work that resists that bureaucracy, since the care must be paid for, simply doing so is a savings in the greater community, enriching the greater community.

Such a program also protects ordinary people from one of the ravages of hyperinflation, a real risk since the dollar might be said to maintain value only due to the indulgence of foreign governments.

[rednecka2z]

I have to disagree on the brief recession. The Middle East governments Have purchased a lot of the Bank Debt. A financial collapse even in the short term will be catastrophic. I't will happen either way but the sign of doing nothing will elminate the our Defiect spending ability. It won't be the Government taking over our banks, It will be Middle East Governments.

[Possumpaul]

The trickle down effect is fallacy. It doesn't work with foreign aid and wont work here.
Every farmer knows that you apply water to the grass roots and something will grow. Spray it in the stratosphere and it evaporates. Who ever heard of tasty stuff moving 'down' the food chain.
Sure have economic stimulus, but feed the people's money to the grassroots to help the people stuggling with a mortgage. Shore up a tottering edifice from the foundations and dont try to save the gargoyles on the roof. You know who I mean.
I did not believe that Bush could engineer another disaster in the short time he has left, but I have underestimated him.

[Project4NuBostonTeaParty]

That would be "MIS-underestimated him."

[Curlybird]

I cannot conceive of the thinking that in order to stimulate the economy, we need to bail out Wall Street mavens that have made financially and ethically questionable decisions. Does throwing money at people that make bad decisions immediately cause them to make smart decisions? I think not.

Our economy, as it stands now, is predicated on one basic tenet, the ability of the consuming public to rid themselves of their hard earned money by the purchase of an ever expanding number of products and services. That's how it works. The banks just take a piece of the action, an ever increasing piece, I might add.

If anyone does not remember 9/11 and the immediate rush to pass the Patriot Act, this has an all too familiar smell to it. Is this the Economic 9/11? Is this rush to pass the Bail Out without time to properly consider all the ramifications, an Economic Patriot Act? First we lose freedoms, then money . . . What's next??

I say let the market sort it out. The cream will rise to the top. The market rewards good performance and punishes the bad or corrupt. If anything is done, the SEC must be given more oversight and companies more accountability. Return to using GAAP and get those off book liabilities back on the books. We have allowed "creative" accounting practices of a highly questionable nature bring our economy to the brink. What do we do?

Let's fix it now, because it's broke.

[undeluded]

Seems a lot like the scene from the Mel Brooks movie "Blazing Saddles" when Clevon Little's character, the sheriff, threatens to kill the "N____r", (himself), if the crowd didn't give into his demand (to back off).

If we are willing to throw money into a problem, fix health care! Provide universal health care!
Look, here's Congress will to put $700 billion into the banking industry so that banks will start to loan money to other banks and again, last, but maybe not least, ma and pa American and their family. Congress is also considering another stimulus package, somewhere around $67 billion, likely another round of a few hundred dollars to each tax payer. That'll be something just over $200 billion aggregate for the two stimulus packages; that's a fifth of a trillion dollars, doled out in pitiful little amounts to tax payers, in less than a year. AND YET when universal health care is discussed, it's too expensive because it might cost as much as a trillion dollars over ten years (none of the nay-sayers ever want to exclude the economic savings, just the possible cost). Unburdening Americans from the single most onerous cause of bankruptcy in this country would solve a tremendous social injustice and free up billions upon billions of dollars to inject back into the economy. If heads-of-households knew that their families would be protected, they'd be able to afford higher mortgage rates, new cars, etc. That"s the way to stimulate the economy!!

[rednecka2z]

Everyone has the solution!!! Get rid of this administration. Let the Government take it over. (Communism) No one seems to get the "Big Picture"
There is a major Drive to Consolidate the three Money's of the North America. In order to make it happen the U.S Dollar the Canadian Dollar and the Mexican Paso have to have a similar value. This means the US Dollar must be devalued to the Mexican value. Canadian dollars are already tied to the Euro so there would be little impact there. WOW Free World Money Fund. Control the Money and You control the World. Wake up Dumbocrats.