Friday, September 26, 2008

The Bailout

The Actual Truth About The Bailout: The basic purpose of the bailout is to allow banks to sell their toxic assets, mostly mortgage backed securities, for more than they are worth. I.e., to give free money to banks and financial companies.

The reason cited is that banks with lots of these assets cannot borrow money from each other, because one bank will not lend to another bank if the other bank has a bunch of toxic assets. This is because they don't know if that bank, the borrowing bank, will suddenly declare bankruptcy, wiping out the loan. The Bailout Plan will buy those assets. Thus, the banks will not have those toxic assets, and they will be willing to lend to each other again. This, in turn, is important, because banks usually have lots of their assets tied up in illiquid things, like business loans, so they need to be able to borrow cash when, for example, a bunch of people withdraw their money.

The bailout plan is not necessary because for several reasons.

First, most banks are not in trouble. They did not make the large returns that the now toxic bonds paid. They were conservative. There are enough banks to provide all the credit our economy needs. It should be noted that none of the major financial conglomerates are in trouble, e.g. BofA, Wells Fargo, JP Morgan.

The bailout is for $700 billion (it will ultimately be at least twice, maybe ten times that much). The argument is that only the government can come up with that much money. That is a specious argument. This $700 billion is not just one chunk of money, but a whole bunch of small chunks. The private market will provide capital to save the banks that can and should be saved. Private capital has already saved Morgan Stanly, Goldman Sachs, and saved the depositors of Washington Mutual. Without the bailout, the worst managed banks and financial companies, those that cannot raise capital, will fail. And guess what? They should fail

The only things the bailout accomplishes are(1) saving a group of recklessly managed banks and financial companies that made exorbitant profits for years by investing in risky securities, and (2) giving free money to strong banks, that don't really need it, but will happily take free money.

The overall effect of the bailout will be negative for Main Street. The positive effects of the $700 billion of printed money pumped into the banks will be more than offset by the negative effects of a declining dollar, increased inflation, and the structural effects of keeping all of the bad financial institutions in business.

And, of course, can there be any doubt that there will be wholesale corruption? This $700 billion is likely to be little more than a piggy bank for the administration and its friends. Do you think a bank with shareholders that are enemies of the administration will be getting loans? Fat chance. So the other result will be that the Administration will be able to give its friends a huge business advantage over its enemies.

Frankly, we'd be better off funding increased amounts of insurance deposits (the FDIC) to make sure that depositors don't lose their money, (even over $100,000). That would prevent bank runs.

Then, the government could handle crisis individually, as they come up. But it the private market will not come in to save an institution, there is no conceivable reason that the government should.

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