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

[ScarletKnight1307]

The Europeans are having to bailout their banks because they were doing the same thing as we were.

http://madeconomicscientist.blogspot.com

we borrowed too much money on temporary rates expecting to be able to refinance down the road at a lower rate fully inflated by Home values and were trapped in unfavorable loans with deflated prices and after missing a payment unable to do anything with banks that did not renegotiate the loans or do workouts as they do with business when they fail.

simply put

the SEC lowered the reserve requirement for banks on wall street so they could spend $40 for every $1 of reserves.

this was done to pump up or inflate a fundamentally bad economy

inflated housing prices

and trapped a lot of homeowners once the bubble bursts

those mortgages need to be renegotiated

every time you see a house go down by foreclosure either by predatory lending

people buying too much house or just not able to afford it then the value of your house goes down

and this crap about it being sub prime and poor people

there are two reasons why you go sub prime

either you have bad credit

or you are borrowing more than what a conventional loan can do

and in the very rich county I live in "OC"

for years 70% of them bought unconventional loans that were adjustable rates

as described on Morning Joe an "Aweful Necessity"

[fuel4thefire]

While the Congress is foot-dragging, the FED is taking action......

http://www.bloomberg.com/apps/news?pid=20601087&sid=aP5hzUWla7Jg&refer=home

Sept. 29 (Bloomberg) -- The Federal Reserve will pump an additional $630 billion into the global financial system, flooding banks with cash to alleviate the worst banking crisis since the Great Depression.

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed's emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The Fed's expansion of liquidity, the biggest since credit markets seized up last year, comes as Congress prepares to vote on a $700 billion bailout for the financial industry. The crisis is reverberating through the global economy, causing stocks to plunge and forcing European governments to rescue four banks over the past two days alone.

``Today's blast of term liquidity will settle the funding markets down, and allow trust to slowly be restored between borrowers and lenders,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. On the other hand, ``the Fed's balance sheet is about to explode.''

[rolandthick]

The bailout kind of diverted Americas attention, didnt it? Clever!!!!

[zbzbzb]

"We also would expect that banks would be reluctant to lend to people who no longer have any collateral." This means that the $700 billion charitable donation would exacerbate the problem because the banks would need to make $700 billion dollars less! The banks need to realize that they must lend to people without collateral - or dig their own hole deeper.
Let the banks dig holes and we the people spend $700 billion on repairing the infrastructure - it would be wiser.

[boyfood]

Now that's the kind of campaign stumping we could use instead of this debate tit for tat. Thank you. I mean that.

[Zan-Gah]

I don't think any corporation should be so big that it can hold the entire world economy hostage. Those that are should be taxed and nationalized. Their stock is cheap now. Buy them out.

Zan-Gah

[LeftRight]

Or at least broken up. I don't necessarily agree with nationalizing them, but the REASON that the Sherman Antitrust law is on the books is because there were businesses which were "too big to fail"

[bestbuddy]

This is a sad day, you can see one after one of these politicians ignoring those who voted for them.....all this bs about helping main street is a crock....although it is inspiring to watch the few on cspan that have some moral fiber and intelligence (of course they are the minority)
---------on a funnier observation,....Doesnt Paulsen kinda look like colonel Klink from the show Hogans heros???--------great article

[jbrown4senate]

The American people are struggling to find jobs, keep their houses, pay for health insurance and put food on their tables.
My recommendation would be to give it to the American people to go toward their homes.
How you ask could this happen? Just like you give information to your checking account in hopes of having your income tax check direct deposited, you would give your mortgage account information to the government for deposit up to $100,000 into your mortgage loan. If you only owed $60,000, then that is all that would be deposited.
This would be available to each family with a foreclosed home (as long as they have not filed bankruptcy) and anyone who currently own's a home to help pay down their debt. Some would have their houses paid off, due to the fact that their loan was lower then the $100,000. Others would have a portion of their home paid for, but still have a remainder in place if their loan was greater then $100,000.
This would help the banks because they would get their money through their clients, while still giving relief to the public.
If we only put a Band-Aid on this, then when the next round of adjustable rate mortgages comes due and increase again, we will be right back where we started and there will be a request for a bailout all over again.
By helping homeowners we help the corporations, there by helping the American people.

Sincerely,

Jackie Brown

[bestbuddy]

Ok wow , I did not expect this vote result...I stand corrected...[although it is inspiring to watch the few on cspan that have some moral fiber and intelligence (of course they are the minority)]
...Ultimately I think this is a ploy by the Bush admin. to be able to shift blame when the stuff hits the fan for real after Obama takes office...doesnt matter ...pass or no pass...we are in for trouble

[KillTheMessenger]

May I ask a stupid question here? Do some posters understand that the meaning of "billion" in the US is different from e.g. "billionen" in German?

Here is a chart to help translate:

1 million = 10e6 = 1,000,000
1 billion = 10e9 = 1,000,000,000
1 trillion = 10e12 = 1,000,000,000,000

In the German language this would go like this:

1 millionen = 10e6 = 1,000,000
1 millioarde = 10e9 = 1,000,000,000
1 billionen = 10e12 = 1,000,000,000,000
1 billiarde = 10e15 = 1,000,000,000,000,000

As you can see, the words for "billion" and "billionen" have different values and they differ by a factor of 1000, which might explain why so many believe that $85 billion divided by the number of people in the nation would allow everyone to buy a home, where in reality it allows at best to get a new washing machine.

[frank1569]

Again, let's review:

Rounding up for easy math, each $1 trillion of TAXPAYER money gifted to the bank robbing cartel divided by 130 million TAXPAYERS equals $8,000 PER TAXPAYER.

So: we got the present bailout scheme at $1 trillion ($700 billion + $300 billion because we all know we're being lied to, again): $8,000 PER TAXPAYER. And we got this, just today: "Fed pumps another $650 billion into foreign banks...": that's $4,800 PER TAXPAYER.

Ya with me? We're at $12,800 PER TAXPAYER. Add in the $2 trillion in bailouts and cash-pumpings so far this year (that we're aware of,) for another $16,000 PER TAXPAYER. And, let's be conservative, another $2 trillion in "toxic" Freddie/Fannie "assets," for yet another $16,000 PER TAXPAYER.

That's $44,800 PER TAXPAYER, the average of whom nets $25,000/year.

IOW, the Fed is handing the bank robbing cartel about 2 years worth of the average taxpayer net income PER TAXPAYER.

Not a little pissed off yet? Then toss in another $24,000 PER TAXPAYER to cover the Iraq/Afghanistan illegal invasions/occupations (4700+ dead, 300,000+ physically/mentally maimed,) $8,000 for the just passed $1 trillion Pentagon budget, and - ta da! - $80,000 PER TAXPAYER to cover the National Debt.

Now then: which God is still blessing this f**king country exactly...?

[KillTheMessenger]

It really took you this long to notice that this nation is living on credit? Interesting... there were hundreds of important people pointing that out for decades.

But maybe they were just not important enough? Thank God we have you now. You will make it clear to everybody that this can't go on like this.

:-)

[sikofit]

Excellent comment. I agree with you 100%. We need a revolution!

[norkas]

LOOK UP THE WORD TREASON

Then you will see what many did to this country knowing what the fallout out would be..

Yes Treason and all of you should be saying it because you will see what Lowlifes did to this great people and country.

[BeltwayBette]

"President Bush is confident that this bailout will do the trick. Didn't he say that about terrorism and Iraq?

Do your family a favor. Spend fifty cents to call 202 224-3121 (Congres),ask for your senator and JUST SAY NO.

Ask him or her why they are folding when they know that 700B is blackmail being demanded by wall Street to keep them from destroying our pension funds and 401 K plans if they don't get the whole $700B NOW.

Ask why $700B when Paulson said "It's just a large number I picked out of my head'?" BS - IT'S A NUMBER ***PUT INTO HIS HEAD *** BY BUSH AND HIS WALL STREET CRONIES.

Ask why there couldn't be payments made in increments so we can see how this bailout is working before we rip our naiton off -- or put its security inthe hands of our largest debt holder -- China?

This is a rip and run tactic the Bush gang is pulling -- Call 202 224 3121

Send emails to your candidate and say this: YOU CAN DO BETTER. NO GUTS NO RE-ELECTION.

A military veteran for our Nation and our middle class. --while it still exists. i've lived in countries where there are only the very rich and the very poor. And it's not a pretty picture. . AT least not for the poor.

[TJC]

Unfortunately we are hearing only those in favor of the bail out and those opposed. If you are opposed to the bail out then be sure you have the correct solution. I don't believe throwing money at a situation is the answer but unfortunately this is a money situation. The financial institutions have taken no responsibility in this crisis and given a two year warning, have not suggested any "Main Street" solutions and are guilty by neglect in this crime. They knew the Bush team would bail them out. I believe they timed it just right for themselves.

[hellboundtrain]

Kill the Beast! Bury it! Stand for integrity in the fullest sense of its meaning.

VOTE NO!

What if the US needs 5 trillion, and not the 700 billion that is proposed?
What if it doesn't work?

WHAT IS YOUR BACK-UP PLAN, SIRS AND MS?

[cwcarman]

Apparently, the Bush administration is consistent in lying to the American people.

[KillTheMessenger]

True, but what does that have to do with bank balance sheets going negative?

[LeftRight]

Nothing directly. THAT has to do with bush's deregulation, not his lying. What has to do with his LYING is that he's claiming that this needs to happen RIGHT NOW!!!! No time for debate, just give it to me!!!

[scrltpmprnl]

I'mbothered by the pitch that it's credit that keeps America going. It's not credit, its actual wages. Americans used to use credit only for houses and cars. They never used credit at the gas pump, the super market, or the movies. If something happened they tightened their belt, did without the non-essentials, and recovered. I think we're being manipulated under the Greater Fool Theory, with the idea that the path to the American way of life is through credit. We'll all end up living indentured to these big banks, like, for example, the miners that were forever in debt to the mining company. These people lived in company homes and shopped at the company store. They could never escape because the system was manipulated to keep them in debt. The problem is not credit, the problem is lack of jobs that pay real wages. A real wage is in the hand. Credit is an idea that you will be able to pay in the future. But accidents happen, children are conceived, health problems inevitably occur. Sadly, this bailout will inevitably pass. 30 years from now our grandchildren will be burdened with taxes to pay for the wars we are now in, and these banking crises. All they will know is that their lives are not as free or as prosperous. Who knows, we may end up being company workers, living in company homes and shopping at the company store.

[LouisvilleLiberal]

I think you are on to something. It seems to me that this cash infusion is to loosen up credit again. I guess if we all borrow our share of the $700Billion ($7k to $8k per taxpayer), it will get the economy going for another couple of years.

The problem is that it won't last. Where will the next bail out come from?

America, unfortunately, is going to have to pay down it's debt and American's are going to have to follow suit. Interest rates are going to have to go up and we are going to have to tighten our belts for a decade or so to recover from the last decade.

I think this bail out is an effort by Wall Street to avoid the inevitable. Let's face it, Bush doesn't understand what Paulson and Bernake are telling him so they are pulling the strings.

I think Wall Street actually wants Democratic leadership so that the deficit gets paid down and the working class gets some financial security in the form of health care. That will actually make them save more - as opposed to borrowing more - which will actually be a boon for Wall Street.

[zaz33]

Give every American $425,000 dollars. Let the citizens make the bank deposits. This can be done by borrowing 85 billion rather than 700 billion.

[KillTheMessenger]

Wow, did somebody fail math in school. Please use a pocket calculator to verify that $85 billion divided by 300 million US citizens is a mere $283.

:-)

[LeftRight]

Every American $425,000. Let's assume the numbers are correct, and we are at right around 300,000,000 (300 million) American citizens. Multiply that by $425,000 (425 thousand dollars) and you come up with a figure of 127,500,000,000 (127 trillion 500 billion dollars). This shows that the math is COMPLETELY off, since this is not even giving us that number of 85.

In order to make your math turn out, we should divide $85,000,000,000 (85 billion dollars) by 300,000,000 (300 million Americans) and we then come out with $283.33.

[midhenry]

Amazing. Basic math, discussions on what the correct answer is, yet everyone "knows" what the problem is and the solution to the current financial crisis. MBO, CDO, SIV, tranche, capitalization, quant, leverage, deleverage...... Oh, whatever, no need to actually understand technical details - the problem is that they're all crooks, so just string em up, vote em out, and cynically believe any conspiracy theory that reinforces one's personal "facts".

Maybe if we just take out our pocket calculators we can out think Bernake and Paulson. Oh.... sorry, we don't need to do that cause we already "know" the answers.

[zaz33]

KillTheMessenger - Thanks for reminding me of my lack of math skills. This plan has been circulating so I thought I could be vague. I also forgot to mention this was for every American over 18. Here is whats circulating.
200,000,000 citizens over 18
85,000,000,000 divided by 200,000,000 equals 425,000
425,000 less 30% taxes equals 297,500
If you're still around ,have at it. - calculaters give me a rash.

[LeftRight]

85,000,000,000 (85 billion) divided by 200,000,000 (200 million) equals 425. Not four hundred twenty-five thousand. Simply four hundred twenty-five.

Using that theory (I got the email too) we would end up paying 85 TRILLION dollars in order to give every American 425 thousand dollars.

[sdsell08]

When can I see who voted for this bill? November is coming and I want to make sure I don't hire the dweebs who ruined me. I cannot afford to send my daughter to College don't even know if its worth her to go since she would have to move to India or China to make money.

[oldfart1]

Wrong. This bill is necessary. The money is already gone, and a lot of it was mis-spent on houses we can't afford, in places we wont' be able to get to when gas reaches $10/gallon in 3 years or so. The bankers raked off their usual 10-20%, and some did even better than that. But no matter what happned, the money is gone.

The real question is, why are so many Americans still voting for the people who were supposed to be minding the store to see that this wouldn't happen?

Senate minority leader Mitch McConnell stated that "When there's a fire in your kitchen, you don't want someone stopping the firefighters..." The credit and housing fire began in 2003, when Alan Greenspan, then head of the Federal Reserve, endorsed variable rate subprime loans as a way of stimulating the economy and helping re-elect George W. Bush. When things began to get out of hand in 2005, Nancy Pelosi criticized Greenspan, saying he had compromised the Fed's independence. Not so, said Sen. McConnell: Greenspan “has been an independent player at the Fed for a long time under both parties and made an enormous positive contribution”.

[LouisvilleLiberal]

McConnell is actually in danger in a very red state. The guy running against him is a wealth criminal who has run for every open office he could in the last 6 years and lost every time. He has a bad reputation for ripping off the government in nursing home and VA care businesses....and somehow has managed to stay out of jail after multiple scandals.

However, I am willing to send this criminal to Washington for one term just to get McConnel out. And, I think I am in the majority. This has nothing to do with the Bail Out....rather it has to do with Republican leadership over the last decade.

Nevertheless, I am suspicious of this bail out and am against in in principal. I suspect that we will know shortly after the bill passes what little effect it has on the little people's IRAs and 401ks and the retirement funds of all the baby boomers that were hoping to retire soon.

[garycsan]

Here's a stupid question. There were 138M taxpayers in 2007, that number includes the gamut from many who paid zero but filed a return to the few big payers. In my simple minded head I divided $700B by 138M and I get about $5M. How could we have than much out in bad mortgages? Very very few very very wealthy people have mortgages that big. We could save a lot of money by just giving every taxpayer about $1M adjusted for their nominal tax rate. Now that would be a stimulus package!!!

[KillTheMessenger]

$700 billion/138 million people = $5072.

Please go back to math class. Do not collect $5000.

[midhenry]

Has it occurred to you that if you cannot due basic long division that maybe your thoughts on the necessary ingredients to a stimulus package might be a little wobbly?