The shock on Wall Street was palpable: On September 29, 2008, the U.S. House of Representatives, facing near-universal outrage from its constituents, rejected the Bush-Cheney administration’s proposal to bail out Wall Street high rollers by lumbering taxpayers with their bad debts.
Both sides of the debate had some good arguments.
On one hand, it’s important to do something quickly to get credit markets moving again.
On the other hand:
- The original Bush-Cheney proposal was pretty bad. It gave U.S. Treasury Secretary Henry Paulson (a Wall Street insider) near-dictatorial power over the bailout and gave his buddies on Wall Street a free ride. That was a non-starter, as Paulson probably knew when he presented it: it was merely an opening offer for negotiation.
- The compromise proposal that the House rejected was only somewhat better.
- Congressional offices have been deluged with calls from angry constituents telling them to vote against any bailout.
- Every member of the U.S. House of Representatives must face the voters in an election five weeks from now.
What critics of the current proposal fail to see, I think, is that we might not have a really good option available: only a choice between bad options. This crisis seems to be a straightforward application of disaster capitalism: A bunch of bankers made a ton of money by issuing risky loans, then a bunch of Wall Street operators made a ton of money by hiding the risky loans in complex investment packages and selling them. The architects of the disaster believe that the only way to protect the world economy from unacceptable damage is to bail them out, so they expect government to do it and the taxpayers to put up with it.
Because the bad loans are hidden, nobody is sure what companies are worth and nobody trusts investment firms. That’s the worst part of the problem. It’s as if you wanted to buy apples, and the seller presented you with 100 crates of apples. You know that some of the crates contain bad apples, but you don’t know which crates or how many bad apples they contain.
If you knew that every crate had 10% bad apples, or even 99% bad apples, you’d know what to pay for a crate of apples. But because you don’t know, you have no idea what to pay, and no sale is possible. That’s basically what’s happened to banks and investment firms. Nobody is sure what their assets are worth, so people are sitting on their money and waiting for things to shake out. Unfortunately, the world economy is what’s shaking.
It’s a bitter pill to swallow: both for taxpayers, who work hard at honest jobs to earn a tiny fraction of what banksters and Wall Street operators get; and for legislators, who are caught between their angry constituents and their largest campaign contributors. It also dramatizes a point well made by America’s only socialist Senator, Bernie Sanders of Vermont, that “if a company is too big to fail, then it’s too big to exist.” Once upon a time, the U.S. government took seriously the problem of concentrated economic power, but no more. One suspects that its laissez-faire attitude is about to change.
The Democrats improved the Paulson proposal by insisting that any bailout of banks and Wall Street be tied to:
- At least nominal regulation of the bailed-out firms, including limits on pay and bonuses.
- Help for average working Americans who face foreclosure and other financial difficulties.
The insurgent Republicans have improved the Paulson proposal by insisting that the deal at least try to minimize taxpayers’ financial exposure.
The goals that any bailout absolutely must achieve are:
- To restore liquidity to credit markets.
- To restore confidence in the trustworthiness of financial institutions.
- To do it soon.
On the other hand, it’s important to keep things in perspective. As I noted in my previous blog article, the Wall Street declines are troubling but also smaller in percentage terms than we saw in the 1987 market crash, which had almost no impact on the real economy. We are indeed in for a nasty recession, but the declines in stock prices per se have little to do with it, even if they give a stomach ache to anyone who has a 401(k).
Nobel laureate economist Joseph Stiglitz has an excellent article about the situation. Interestingly, The New York Times hasn’t mentioned a word about Stiglitz’s proposals. Stiglitz says it better than I do here, but then, I don’t have a Nobel prize in economics.
Copyright 2008 by N.S. Palmer. May be reproduced as long as credit is given.
Follow-up: The October 1, 2008 issue of The New York Times has an excellent article here about why the bailout makes people so angry, and why a loss of trust imperils the economy. Another excellent analysis here in The London Times spotlights the fact that “revenge on the banksters” is a natural but counter-productive response.