September 23, 2008
Economics Department
Why Not Bail Out the GOOD Banks?
This is probably wrong in so many ways, but why are we helping the bad financial institutions? Wouldn't it make more sense to help out the good ones?
I think, first of all, that the plan is not to simply give away the $700 billion. Instead, the U.S. Treasury will take over bad mortgage investments. I think the way this works is that if the government buys $100 million in bad mortgage investments and, say, only gets back 75 cents on the dollar, the government will have spent $25 billion to add $100 billion in liquidity to the economy. At that rate, spending the full $700 billion will free up $2.8 trillion from bad investments. (I have no real idea if these figures make sense.)
Second, as I understand it, the big fear in this crisis is that a series of institutional failures will cause a credit crunch that makes it hard for companies to operate from day to day and impossible for them to expand. This could cripple production and produce a huge involuntary contraction in our economy. Preventing this credit crunch is why we want to add liquidity by pouring in cash.
But why do we have to pour cash into the bad banks? Wouldn't it add just as much money to the credit markets if we poured the money into the successful banks?
As for the bad banks, we just let them bleed to death in the street. The remaining banks, now flush with U.S. Treasury cash, will fill in the gaps and prevent a credit crunch.
This solves the credit crisis, avoids rewarding financial institutions for their failure, and because we're lending the money to financial institutions that have not driven themselves into the ground, probably costs less.
One of the creeds of the economist is that there's no such thing is a free lunch, and this sounds like a free lunch to me. That means I'm probably misunderstanding something important about financial markets, and my plan is hugely flawed.
But I'll bet it's not the craziest plan you'll hear before this is all over.
3 Comments
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there are no good banks. when i tried to buy my home here in indianapolis over 11yrs ago i still remember all these mortgage brokers that wanted me to get the bigger loan. you can qualifiy for this and that just change your taxes to 9 dependants and at the end of the year it will balance out with irs. yea, right, whatever. you would have thought i commented manslaughter when i asked for a 30yr fixed rate loan back in 97. omg and i qualifiyed for a 150,000 home but i wanted that 60,000 home i was such a sinner. whatever. my taxes have doubled over the years. my finances did loosen up and i am almost paid in full. being free and clear is sticking it to the man.
I'm not sure that doesn't make sense. Heck, I'm not sure that it doesn't make sense to bail out the bailable borrowers, and letting the benefits trickle up to the CDO owners.
As I learn more, I'm starting to get an inkling that this doesn't make sense.
The best analogy that I can come up with is that these financial firms are like a bunch of cars on the highway, and some of them are breaking down. As they gring to a halt, they block traffic and threaten to cause a giant traffic jam. The federal government is a tow truck, trying to clear the road, and it only makes sense to tow the cars that have broken down.
I don't know if that analogy is an accurate description of our financial system, but I think it's consistent with the argument for bailing out failing companies.