[Peace-discuss] Blazing Saddles in NY

[C. G. Estabrook]

	September 29, 2008
	Dean Baker
	Why Bail? The Banks Have a Gun Pointed at Their Head
	and Are Threatening to Pull the Trigger

If you have a real story, you don't have to make up phony stories. That's pretty 
straightforward.

I've heard lots of phony stories. Much of the country's political and economic 
leadership has been running around raising the prospect of the Great Depression 
and a breakdown in the banking system (I actually had taken the latter 
seriously). These stories are absolutely not true.

There is no plausible scenario under which the no bailout scenario gives us a 
Great Depression. There is a more plausible scenario (but highly unlikely) that 
the bailout will give us a Great Depression. There is no way that the failure to 
do a bailout will lead to more than a very brief failure of the financial 
system. We will not lose our modern system of payments.

At this point I cannot identify a single good reason to do the bailout.

The basic argument for the bailout is that the banks are filled with so much bad 
debt that the banks can't trust each other to repay loans. This creates a 
situation in which the system of payments breaks down. That would mean that we 
cannot use our ATMs or credit cards or cash checks.

That is a very frightening scenario, but this is not where things end. The 
Federal Reserve Board would surely step in and take over the major money center 
banks so that the system of payments would begin functioning again. The Fed was 
prepared to take over the major banks back in the 80s when bad debt to 
developing countries threatened to make them insolvent. It is inconceivable that 
it has not made similar preparations in the current crisis.

In other words, the worst case scenario is that we have an extremely scary day 
in which the markets freeze for a few hours. Then the Fed steps in and takes 
over the major banks. The system of payments continues to operate exactly as 
before, but the bank executives are out of their jobs and the bank shareholders 
have likely lost most of their money. In other words, the banks have a gun 
pointed to their heads and are threatening to pull the trigger unless we hand 
them $700 billion.

If we are not worried about this worst case scenario (to be clear, I wouldn't 
want to see it), then why should we do the bailout?

There has been a mountain of scare stories and misinformation circulated to push 
the bailout. Yes, banks have tightened credit. Yes, we are in a recession. But 
the problem is not a freeze up of the banking system. The problem is the 
collapse of an $8 trillion housing bubble. (It was remarkable how many so-called 
experts somehow could not see the housing bubble as it grew to ever more 
dangerous levels. It is even more remarkable that many of these experts still 
don't recognize the bubble even as its collapse sinks the economy and the 
financial system.) The decline in housing prices to date has already cost the 
economy $4 trillion to $5 trillion in housing equity. This would be expected to 
lead to a decline in annual consumption on the order of $160 billion to $300 
billion.

Given the loss of housing equity, I have actually been surprised that the 
downturn has not been sharper. Homeowners had been consuming based on their home 
equity. Much of that equity has now disappeared with the collapse of the bubble. 
We would expect that their consumption would fall. We also would expect that 
banks would be reluctant to lend to people who no longer have any collateral.

This is the story of the downturn and of course the bailout does almost nothing 
to counter this drop in demand. At best, it will make capital available to some 
marginal lenders who would not otherwise receive loans. We should demand more 
for $700 billion.

For the record, the restrictions on executive pay and the commitment to give the 
taxpayers equity in banks in exchange for buying bad assets are jokes. These 
provisions are sops to provide cover. There are not written in ways to be 
binding. (And Congress knows how to write binding rules.)

Finally, the bailout absolutely can make things worse. We are going to be in a 
serious recession because of the collapse of the housing bubble. We will need 
effective stimulus measures to boost the economy and keep the recession from 
getting worse.

However, the $700 billion outlay on the bailout is likely to be used as an 
argument against effective stimulus. We have already seen voices like the 
Washington Post and the Wall Street funded Peterson Foundation arguing that the 
government will have to make serious cutbacks because of the bailout.

While their argument is wrong, these are powerful voices in national debates. If 
the bailout proves to be an obstacle to effective stimulus in future months and 
years, then the bailout could lead to exactly the sort of prolonged economic 
downturn that its proponents claim it is intended to prevent.

In short, the bailout rewards some of the richest people in the country for 
their incompetence. It provides little obvious economic benefit and could lead 
to long-term harm. That looks like a pretty bad deal.

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