The way the proposed bailout is being talked up, you get the impression that the whole world depends on the Bush administration and the Fed coming to the party with the best part of a trillion dollars. The US economy depends on it, our economy depends on it, the capacity of the US to resist wicked people in foreign lands, even the ongoing success story of the Chinese powerhouse (and hence our mining sector) etc. The implication is that we are all being bailed out.
But there are dissenting voices, claiming that the bailout of badly managed financial institutions will have more downsides than upsides, in the form of inflation and further damage to the dollar, plus the message that the US Government will come to the rescue whenever serious mistakes are made by large numbers of borrowers and lenders (a la the Savings and Loans debacle).
The dissenters claim that the failure of some financial institutions on Wall Street will simply represent the market catching up with bad practices.
Hence the rescue package cannot prevent so-called economic disruptions. If anything, government intervention would make these disruptions much worse. Again, a better alternative is to let the market do the job. The market’s ability to make swift adjustments without much drama was vividly illustrated only a few weeks ago when the very large investment bank, Lehman Brothers, was allowed to go belly up. The world did not come to an end. Instead, this was a healthy development. A money loser was eliminated from the market. This freed up resources to promote growth.
One could have made the case that when Lehman was on the brink it was too big to fail assets of $639 billion and employing over 26,000 people. Yet in a few days the market, once allowed to do the job, reallocated the good pieces of Lehman to various buyers and the bad parts have vanished.
Likewise Merrill Lynch, which was bought by the Bank of America, will see the good parts of it reinforced while the useless parts are likely to be removed.
On September 18, 2008, Washington Mutual, the largest US saving and loan bank, was forced into liquidation. The bank had $307 billion in assets and $188 billion in deposits. What prompted the closure are heavy losses on its $227 billion book of real-estate loans, of which a large portion was in subprime mortgages.
The bank lost $6.3 billion in the nine months ending June 30. Against this background, and coupled with customers withdrawing $16.7 billion over the past ten days, government regulators decided to close the bank.
Observe that this was the largest US banking failure. Note that the closure of the bank didn’t result in the end of the world. JP Morgan Chase bought some of the good assets of Washington Mutual for $1.9 billion.
They suggest that the amount of economic activity tied up in real estate loans represents a very small percentage of the national GDP so it should be kept in perspective. They point out that the US is an economic powerhouse and the productive capacity of the real economy remains in place – the infrastrucure, even the houses, the people, the skills and all the other banks and financial institutions that have maintained sensible commercial lending policies.
Nicholas will be relieved to read that I don’t claim to know enough to pontificate but I am prepared to ask some simple questions that need to be answered so bewildered people can get a grip on the issue.
1. Who is actually being bailed out? How is the trillion dollars going to be divided up? Who benefits?
2. What happens to the home loan defaulters in the event of (a) the bailout (b) no bailout? Are they in the street or do they get to re-negotiate their repayments?