Listening to some of our nations top political leaders, one gets an uneasy feeling that The Great Depression II is right around the corner, unless we entrust the federal government to engage in a massive 700 billion bailout plan that will ultimately save 'main street' from Wall Street's mess. But if that's the case, why have over 200 leading economists from Harvard, MIT, Northwestern, the University of Chicago, and other respected institutions signed a petition opposing rapid passage of this bailout?
In basic English, the argument in favor of the bailout goes something like this: banks and other financial institutions have purchased mortgages which, for many different reasons, are now worth far less than their purchase price. As a result, banks have lost money by purchasing them, and they can't convince anyone else to buy them. If they can't sell their paper securities,' they can't raise cash. This, in turn, means they have no money to lend, and credit markets will be so tight that 'Main Street' will grind to a halt: businesses will not be able to borrow funds to meet payroll or expand their enterprises, and consumers will be unable to purchase homes and cars or pay their college tuition bills.
This line of reasoning scares many Americans (as its meant to), but is faulty for several reasons.
First of all is the cost. What is not being revealed to the American public is that over the last 5 months, the Federal Reserve Bank has already provided over 1.1 trillion dollars to financial institutions, in exchange for paper securities, in order to inject cash into the banking system. The 700 billion bailout is in addition to that which has already been injected with an accompanying bill of over $17,000 per American household before this is over.
Second is the risk. I asked a spokesperson for the Federal Reserve Bank of Boston why Washington Mutual didn't take advantage of the Federal Reserve's Bank's cash offer over the last few months. I was told that there were financial criteria that needed to be met in order to obtain that funding: in other words, the less credit-worthy, the less stable institutions were unable to partake. That means that the 700 billion Congress is about to authorize will be used specifically for those institutions whose paper is the most worthless, leaving the US Taxpayer with nothing in return for its "loan' to these inept banks. Some commentators suggest that in reality, the taxpayer will make a profit on this paper, but if that was a realistic possibility, there wouldn't need to be a government bailout: some enterprising institution would have purchased that paper already.
Third is the Moral Hazard created by helping the inept. No one is guaranteed success in a market economy. In the rough and tumble of competition, some win and some lose. If the most ineffective, negligent, inattentive and even fraudulent activities are rewarded by a bailout, what message does this send to the banks who were prudent in their decisionmaking over these years? The well-run banks ought to profit, and ought to be stronger and inept banks close; instead, we, the taxpayer will be helping the most irresponsible institutions stay afloat, and will pay interest for the 'honor' of so doing.
Fourth is the unfounded fear that credit will completely dry up. The fact is, banks do not lend their own money; they lend their depositors funds. Institutions may crash and burn, but their depositors funds are insured by the FDIC, and those depositors will simply place their funds elsewhere. Keep in mind that when Merrill Lynch was subsumed by Bank of America, there was no catastrophe: there was simply an efficient movement of resources. The Market worked without a taxpayer bailout. Similarly, when Washington Mutual "collapsed," they opened the next day as part of JP Morgan. Not one depositor lost money, not one customer lost their line of credit and not one dollar of taxpayer was required.
The Bailout is an unnecessary, expensive return to Feudal Britain, where the "Crown" owned title to all the land and used tax money to keep its favorite business partners afloat. This is precisely the time to allow the Marketplace to weed out poor investment firms and negligent banking facilities and allow the rest of us to enjoy the prosperity that can be gained by resting secure in the knowledge that the best and brightest firms have been allowed to carry on financing activities.
©2008 Tully, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Thursday, October 2, 2008
Last modified: Thursday, October 2, 2008
The views expressed in this article are those of Tully only and do not represent the views of Nolan Chart, LLC or its affiliates. Tully is solely responsible for the contents of this article and is not an employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
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Reader Comments:
Posted By: J.B.W.
Date: 2008-10-02 17:08:48
When will the time come that those responsible for the mistakes will be held liable. I am not talking about the average citizen. (were already held liable) I have in mind the mortgage industry. It was greed and competition that passed those questionable loans. And was there not new -rules- that provided more protection to lenders in a bankruptcy?? I say "YOU MADE YOU BED, SLEEP IN IT" It was our savings you loaned out now we are expected to pay ourselfs back? Of course corporation will still make a sizable profit, oops. they already did. Our household has had a reduction in salaries, increase in living expenses and now we had to cancel our six week international vacation. THIS IS J.B.W. AND I APROVE THIS MESSAGE. HA HA.
Posted By: Subprime Showtime
Date: 2008-10-02 19:03:45
http://subprimeshowtime.com/
The bailout now contains $185bn of earmarks and must be stopped. It now contains:
- Give King Paulson unlimited financial power and $700 billion.
- Build a national fingerprint registry.
- Give a tax exemption for any machinery “(other than any grain bin, cotton ginning asset, fence, or other land improvement)” used in a farm business
- Require insurers to cover mental health physical expenses.
- “Forest Receipt Payments To Eligible 9 States And Counties”, whatever that is but it doesn’t sound like a subprime-related issue.
- Budget for mine reclamation fund gets an additional $9,000,000 in 2010.
- Increase in limit on cover of rum excise tax to Puerto Rico and the Virgin Islands.
- A tax exemption for wooden arrows, which must “measure 5⁄16 of an inch or less in diameter” and cannot be “suitable for use with a bow”.
- A seven-year cost recovery period for motorsports racing track facility.
- An extension of the economic development credit for American Samoa.
- Some sort of tax exemption on Christmas tree ornaments that I simply didn’t understand.
Posted By: Master C
Date: 2008-10-03 12:52:04
Dear Tully,
Your reasoning about the bailout is about as specious as those who say that we never landed on the Moon. Because there is no breeze blowing on the Moon, when you see the flag unfurled, you assume that someone is trying to put one over on you. Well, they have, but it's only your myopia that's causing it.
You add up some BIG numbers and you become horrified. My God, it's $17,000 per household! Well, welcome to the world of BIGGER numbers, and take a look at the revenues and expenses of just the oil companies and you may realize that these are much smaller potatoes. Take a look at what some companies pay in just ADVERTISING, and you'll see that it's even more than that.
About the only thing you seem to know about "Risk" is that it's a game. If you understood the DOWNSIDE to NOT DOING anything about the financial collapse, you'd understand what REAL risk is. Just because you don't see any foreclosures and bank closings yet doesn't mean that they won't happen in a few months. You don't seem to know the meaning of the word "lag time".
Moral hazard isn't just a matter of letting someone get burned for doing the wrong thing. In this case, letting someone get burned may incinerate the WHOLE HOUSE! You don't see the breadth of what will happen as one domino pushes into the next. You somehow think you're insulated from the effects of the collapse, but NO ONE is. Even the BIG BOYS are gonna lose lots of stuff. It's just not going to hurt them as much as it will us. The BIG BOYS lose stuff. The rest of us LOSE EVERYTHING!
You put 42 economists in a room and you'll get 56 opinions. Just ask them what's going to happen to employment or interest rates or GDP for the next year, and they'll just give you some mumbo jumbo. So, why would you think they're in harmony over this? They just don't want to be ignored.
However, you and your article should be. Not only haven't you raised any good reasons NOT to BAIL OUT the financial sector, you haven't even given a good reason not to push you out of the boat when the ship starts going down. I hope you're standing next to me. I won't be timid.
Master C
the flag, so you assume there are no wires
Posted By: Tully
Date: 2008-10-03 13:41:49
Master C,
Like the hysterionics in the House, you jump from Point A (current credit issues) to Point Z (Armageddon) without connecting any points in between, without explaining how any of these doomsday scenarios will develop, or giving us any specific chain of events.
If you did, we could easily shoot down your silliness. Instead, you choose the way of the Statists: scare us, insist on emergency action, and change the face of finance overnight.
Posted By: Trude Blomsoy
Date: 2008-10-04 19:30:04
Dear Tully,
Just to let you know that "Forest Receipt Payments" are money
from the Federal Government to states who have had their federally owned forests locked up due in part to Clinton's forest
policies and the Endangered Species Act. This stopped logging,
(and thus greatly increased unemployment) and caused schools to close as they were dependent on income from timber sales.
Posted By: willy
Date: 2009-08-02 12:29:17
The concern I have you stated well in that the bailout rewards "bad" behavior. If we consider that rewarding bad behavior tends to embolden the bad behavers, and also encourages further arrogance, this is a recipe for our country's darkening morally, (forget about money for a minute) and the erosion of proper social justice. No country is likely to survive in the long run if its moral compass is both broken, and ignored.