The Bailout of All Bailouts is a Bad Idea

Talk today about the Bailouts of All Bailouts eased market fears and generated a giant rally on the Street, but how realistic is it?

On Capitol Hill, Senator Charles Schumer suggested that government inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable. At the other end of Pennsylvania Avenue, Hank Paulson reportedly is considering an agency like the Resolution Trust Corporation, established during the savings and loan crisis of the late 1980s, to take bad debts off the balance sheets of financial institutions.

Problems are: (1) It’s not likely to do all that much good because no one knows how much bad debt there is out there. Even if the government bought a lot of it, investors and lenders still couldn’t be sure how much remained. After all, big banks have already written down hundreds of billions of bad debts, and that hasn’t restored confidence in the Street. As the economy slows, bad debts will grow. Again, the problem isn’t a liquidity or solvency crisis; it’s a crisis of trust.

(2) However much bad debt there may be, that amount is surely far greater than the $394 billion of real estate, mortgages, and other assets that the old RTC bought from hundreds of failed savings-and-loans — thereafter selling them off form whatever it could get for them. The Bailout of All Bailouts would therefore put taxpayers at far greater risk than they are even today, and require an unprecedented role for government in reselling assets. Another major step toward socialized capitalism.

A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street — essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn’t get left holding the bag. And there would be no “moral hazard” incentive for future financial wizards to take giant risks with other taxpayers’ money.

Congress, the Fed, and the Administration shouldn’t be giving more help to Wall Street. Policymakers should focus instead on people who really need a safety net right now — workers who have lost or are about to lose their jobs, who need extended unemployment insurance and health insurance for themselves and their families; homeowners who have lost or are likely to lose their homes, who need additional help meeting mortgage payments and reorganizing their debts; and people who have lost or are in danger of losing their savings or pensions, who need better insurance against possible loss.

The only way Wall Street’s meltdown doesn’t spill over to Main Street is if policymakers begin to pay adequate attention to the people whose wallets really keep the economy going, and who merit more help than the Wall Street tycoons whose carelessness and negligence have put it in such jeopardy.

Originally published at Robert Reich’s Blog and reproduced here with the author’s permission.

One Response to "The Bailout of All Bailouts is a Bad Idea"

  1. Gordon Bayes   September 28, 2008 at 7:12 pm

    I am just an observant lay person, retired with more time to watch. I watched other Americans including even friends and relatives borrow up to their ears and all to often not for dire necessities. Six years ago already I mentioned to a close friend that eventually everyone would be too deep in debt to buy anything anymore, and the way I see it that is what has happened. After all get said and done the government is effectively just going to print more money, and people like me on fixed incomes will watch our assets dwindle; and working people will find it harder and harder to survive. The very rich will have perhaps less, but they will continue to remain fairly reassured because they will have more than enough on which to continue gorging themselves.