Today, the House voted on a bailout package for struggling banks and the measure was defeated. While it is entirely possible that a bailout will still occur, in some form or another, for the moment we should rejoice.
No doubt many will cry that this is a disaster, that we Must Do Something! to prevent an even worse economic calamity. But this notion is wrong. Ever since Secretary Paulson proposed the idea of a bailout, one aspect of his sales pitch has gone largely unchallenged. That aspect is the assertion that such a bailout (regardless of structure) can actually help the situation.
It is important that we act like adults and not panic. In a state of panic we begin to look desperately for a solution, any solution, for the present problem. We may even adopt "solutions" that solve nothing, or even make the problem worse. So before we act, it is important to determine whether the dire consequences cited by Paulson et. al. are actually something that we can avoid.
The primary dire consequence that we have been told to fear is the dramatic downward re-pricing of various securities that our banking system is heavily invested in. This, in turn, may cause numerous banking institutions to fail. There are two questions that must be asked here:
1) Will the bailout actually prevent this re-pricing?
2) Would the bank failures actually be a bad thing?
The assumed answers to both of these questions are "yes." But the answer to these questions is, in fact, "no" on both counts.
With regard to the first question, there is quite frankly a bait-and-switch going on. Anyone who read Paulson's original plan and understands the markets would know that these plans do not intend to prevent a fall in prices. The purpose is to provide a "purchaser of last resort" -- a government facility that would buy these securities at taxpayer expense and then re-sell them later. It is probable that the government will take a loss on these transactions, but the result of such a policy should be clear.
Some of the larger banks will obtain mortgage-backed securities at cut rates thereby allowing them to shore up their balance sheets. The banks that fail first will be cannibalized in order to make the bigger banks more whole. Essentially, the government will be picking the winners here. At no point does the decline in MBS pricing actually stop. It will happen regardless. Housing prices are falling and people are bailing on their mortgages. You can't stop this any more than you can stop gravity. The point is to shore up certain banks at the expense of others.
That one of the banks being saved used to be run by Secretary Paulson is, I'm sure, wholly coincidental.
But what about bank failures? Aren't bank failures one of the signs of Armageddon? This too is misleading.
First, as pointed out above, many of the impending bank failures will still occur even under the bailout. After all, in order for assets to be scooped up at fire sale prices there have to be some fire sales. The bailout will reduce the total number of bank failures, but we have to ask whether that is actually good for the economy.
I'm sure we can all agree that rewarding the bad management of a failing bank is foolish and is likely to encourage future irresponsibility. However, bailout proponents like to point out that bank failures don't just hurt the bankers, they hurt depositors and those demanding loans as well.
With regard to depositors, there are two objections. First, many of the endangered banks are investment banks that don't have traditional demand deposits (i.e. the investors are all knew they were taking a risk by placing their money there). Second, even the banks that do have such deposits are protected by the FDIC which is a bailout mechanism we already have. No starving widows are going to lose their savings as result of a bank failure.
With regard to loan demand, it is true that many businesses are going to base future expansion on their ability to obtain a loan. If there is a temporary shortfall in loan supply, then growth will slow. Some businesses that need credit to keep the doors open will fail. This does sound terrible except when you consider that a society dependent on credit is precisely the imbalance that market forces are trying to correct. If you want a society with a sensible attitude toward debt, then the solution is that people with too much debt go bankrupt.
Furthermore, we should not fear a temporary shortage of lending. Many commentators are acting as if once the banks fail, no more can be made. That's it. Close the doors, we're back to barter, baby! Please, let's be serious about this matter. Having a bunch of new banks arise from the ashes of the old is not the end of the world. In fact, there is no better way to ensure that future bankers are conservative and responsible than clearing out the current crop.
But, you might protest, I might lose my job. My company might fail or my 401K lose half its value. I'm in that club myself. My 401K has lost a lot of value, my job is construction related and business is slow and I own part of my company and could, in effect, go down with the ship. I am afraid of these dark outcomes too.
But I'm not going to let fear rule me, and I refuse to stand idly by while this country is once more ruled by fear. It's time to stop quaking in terror about the economy. There's going to be a recession. It's going to be rough and rougher for some people than others. Let's make sure that the boneheads at the top who made the really bad decisions suffer some consequences too. Rough times are not just for the poor or the middle class. The rich must feel the pain as well.
In short, I support the recession. The right thing to do when businesses fail is to let them fail. We must face this with courage or allow a chosen few to use our fears an excuse to steal from us.