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

[LHoney]

Why hasn't a task force of economists from our finest universities been put to work on this immediately to at least offer an opinion for the American people?

[SidStoic]

The best question thus far!!!

[LHoney]

Thank you - I heard an economist from Harvard spell out on CNN that this was completely UNNECESSARY!!!

[LeftRight]

Because they are the liberal "elite" who might actually be able to come up with something that would WORK, but almost certainly NOT provide $700 Billion to big campaign donaters.

[Observer47]

OUTSTANDING ANSWER!!

[Poboy]

Section 122 of the Bailout Bill increases the national debt from $10.0 Trillion to $11.3 Trillion.

So I content that the true cost of the bill is not $700 Billion but $1.3 Trillion.

http://financialservices.house.gov/essa/final_bill_section-by-section.pdf

[LeftRight]

Actually, the current ceiling stands at $10.6 Trillion.

[Pdubya]

and what i think most of us are missing is what this will do to our currency.

[zenx98]

Bush is NOT a failure! He has succeeded beyond any expectation in returning every corporate globalist expectation to the masters that installed him. Buy this magazine,, or we'll shoot this dog is being used to fire sale the country and the future just in time for the clown prince to bust back to Crawford for good and start "rebuilding his coffers".
Drain the treasury TO
force tax increases by the incoming adminstration just to maintain
prevent national health care
prevent ANY new programs
funnel the wealth up
re-ignite culture war between the haves and the have nots
Remake the basics of the economic system
to facilitate fire-sale sweep up buying of existing assets by remaining whales
re-finance global corporatists
It is beyond me that there are no crowds in the streets ripping up the cobblestones for missiles.

[Realist]

Maybe its abad deal for the people - but then againthe ast 20 years have been a bad deal for the people. They didn;t even touch the bankruptcy law, which Biden and his credit card buddies worked hard to change a few years ago so we the people are made to pay ridiculous debts to cc cos. who charge interest rates higher than any usury law would allow. The again, in the modern US, sicne wyhen does usury matter. The Congress is truly a bunch of criminals - andf eventually we the people will get Pelosi, Dodd, Frank, et al and put them in jail. I surely will work my life to make sure it happens.

[Henry]

Realist,
Just for sport, could you list the allegations you think exist against Pelosi, Dodd, and Frank? It is tough to put someone in jail with "no" allegation of wrong doing. Do you remember Whitewater? Any allegation of wrongdoing with Whitewater? Was there a criminal charge after 7 years of Kenn Starr? Senate Banking Committee with Alphonse Domatoe? House Banking Committee with Leach? (Leach you might note is supporting Obama)
You sound like someone who is shooting blanks into the sky.

[loria]

Why if you are talking about the last 20 years are you only including dems? You aren't much of a realist since the Reps have been in control for all but 8 of those 20 years and those were the best eight years.

Please educate yourself a bit about who is at fault. There is enough blame to go around, but let's start with the party that has had control of the WH for eight years.


As you see Realist and those from the right try to blame this mess on Dems, taking it back to Jimmy Carter and his efforts to help insure minorities were not discriminated against in the mortgage industries, read this. Republicans claiming dems are the only ones at fault is laughable, but that is their new line. They ignore that they have consistently fought for deregulation and less oversight.

http://www.huffingtonpost.com/hale-stewart/whos-to-blame-for-the-mes_b_130044.html

[LeftRight]

Actually, since he is talking about the Congressional leaders, we must look at it from that perspective. You are technically correct, the democrats have had control of both houses of Congress for 8 of the last 20 years. However, SIX of those eight were from 20-14 years ago. Since 1995 the REPUBLICANS have been the ones removing the legal regulations while they controlled Congress, and in the last 8 years (since bushco became president) the gov't has been ignoring the ones that Congress did NOT remove.....

Yeah, that sure looks to me like the DEMOCRATS are responsible!

[LeftRight]

"Given the loss of housing equity, I have actually been surprised that the downturn has not been sharper."

I can tell you why it hasn't been sharper. The fact of the matter is that ALL of the bush economic policies lately (from buying bad debt, to nationalizing Freddie/Fannie, to the $700 BILLION bailout!) have been built with ONE goal: Keeping the economy going long enough to get out of office! Then it will belong to whomever takes over in January! bush doesn't care about the economy as of 12:01 on January 20, 2009!

[Henry]

When the FHLB makes loans (creates and gives money to) to banks that are secured by the loans and/or securities of the banks, it rides the wave of value increase and has to take prudent account of the value decline. In order to do this, the FHLB requires more collateral percentage. The only way the banks can attain this is to diminish their "advance" position from the FHLB. In order to do this, the banks must take "cash" (not capital) and paydown their loans with the FHLB. This "paydown" by the banks to the FHLB actually expunges money. By a simple accounting entry, the loans that funded the money are Paid (they are gone) and the money which originated from the initial booking, too is gone, expunged, it is out of existence by the accounting entry associated with repayment of the loan. . This M-3 variety of money tapers down and along with other similar events creates the so-called liquidity crisis. So the FHLB has to be conservative, even though it participated in the easy money, fast money wave, by supplying the "money" to the party, now they want to make sure they are secure. And so the ebb and tide of the capitalism flows of money.

[loria]

Henry,
Thank you for the information you are trying to spread. We are seeing the Republicans taking the stand that they have no responsibility in this despite being in control for the last eight years. I also see you trying to explain to those of us who really don't have the ability to see the long term consequences of failure to act on this. Many people believe this is a Wall Street bailout when in reality this has just as much to do with all of us as it does with Wall Street.

How many of you might need to get a car?. Were you planning on paying cash? How about college for your child. Do you have the $75,000 you will need to put your child through college in a public university (yes, that is what it costs these days for a four year education at most univerisities in this country)? How many of the local small businesses in your town rely on a line of credit to stay afloat? Restaurants, retail, small builders, etc. They all need credit. If that is cut off, they go under. That means the jobs are lost. Please people. Resist the urge to think this economic meltdown doesn't have anything to do with you and by ignoring it all will be fine. All is not fine and won't be even with the bailout. It's a matter of whether it is a catastophic chain effect that paralyizes the economy.

[rmreddicks]

"By a simple accounting entry, the loans that funded the money are Paid (they are gone) and the money which originated from the initial booking, too is gone, expunged, it is out of existence by the accounting entry associated with repayment of the loan."

A better explanation? Is it an accounting trick? Or is this a matter of "All that is solid melts into air."? The money or wealth is always out there. No matter it's disguise.

[Henry]

rmr,
simple example for you. A while back my mortgage was $35000 and I decided to pay it off. I put $38000 into my checking account and on a payment due date I had the credit union debit my checking account $35000 and their double entry accounting entry was a credit of $35000 to their asset account Loans. This reduced the principal of their loans by $35000 and also reduced my checking account by $35000. The M-1 measure of money in the country declined by $35000 as a result This is really how it works, when a bank makes a loan they create money, when you pay the (principal) loan off you are expunging the same money that was created for the initial booking of your loan.
Money is an abstraction and (other than fed res notes) is all about accounting entries that take place on chartered banks that can "clear" through the fed. Listen to the big boys, Ben and Paulson refer to loans as "credits", the down home expression for money.