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Wednesday, October 01, 2008

"Failure to pass Bailout Threatens All Americans"

Jonah Gelbach:

Failure to pass bailout threatens all Americans, by Jonah B. Gelbach, Arizona Daily Star:  The U.S. House on Monday rejected the Wall Street bailout. This mistake threatens all of us ... on Main Street...

I'll make five main points.

First, we got into this situation because ... housing prices rose too high. Banks and other investors made bets that could pay off only if the market kept rising. Now those bets are underwater.

Second, what if we don't pass a bailout? Our financial sector is caught in a trap. No one's sure which borrowers ...[are] going belly up. Even healthy banks won't lend to other banks.

Usually, when banks can't borrow, they sell off healthy assets. But if everyone sells at once, everyone spirals into free-fall. Since all sectors of our economy depend on credit availability, massive layoffs will occur if this situation lasts much longer. It would take years to recover.

Third, the current bill is a big improvement over Treasury Secretary Henry Paulson's initial legislation. It adds oversight and seeks to limit compensation paid to the Wall Street executives who made bad bets. Most importantly, the new bill limits the bailout's cost by giving us, the taxpayers, a stake in companies that get help. The bill isn't perfect, but it's good enough.

Fourth, many are understandably outraged. After years of billion-dollar compensation for a few would-be whiz kids, financial firms now want help from ordinary working people.

But look at it this way. Imagine your child stands wrongly accused of murder. Along with a co-defendant, she faces execution. You can prove your child's innocence. But if you testify at trial, your child's co-defendant will also go free, even though you know he's guilty. Would you allow your child's execution to convict the guilty guy?

This bailout will help some who have caused the mess, but that's an unavoidable part of helping everyone else. Don't cut off your paycheck to spite a financial executive.

Fifth, this bill isn't nearly as expensive as people seem to think. First, $700 billion is less than some realize. Imagine you run a delivery business that makes $60,000 annually and your van breaks down. It will cost you $3,000 to fix it. Should you fix the van or close down the business? That's a no-brainer.

It's also similar to the bailout, because $700 billion is 5 percent of our economy's 2007 income, $14 trillion, and we'll lose an awful lot more than $700 billion if we let the economy tank. And we'll lose it repeatedly for several years.

Moreover, we're not just going to hand over the cash. The original Paulson plan would have allowed that, but Monday's bill wouldn't. Taxpayers would get a stake in any gains from future sales of the assets the government will buy. And because the government will wait to sell these assets until financial markets have enough capital to operate healthily, these assets might be sold for more later than now. We're putting up $700 billion now, but we'll get some, all or maybe more back later.

There'll be plenty of time to hand out blame. But let's make sure we do that after banking hours — instead of in the unemployment line.

Financial markets and financial intermediaries bring together people who have an excess supply of  loanable funds with those who have an excess demand. But why do those with excess demand want the money? They want it because they believe they can use it to make profits through some business venture. They wouldn't borrow the money if the expected payoff didn't exceed the cost of the loan.

So financial markets channel money to the real economy, and that is the source of the profits you see on Wall Street (beyond the zero sum game among some traders). Loans are paid back - with interest - from the profits the borrower made with the money. Money doesn't breed, simply taking out a loan from a bank won't make you wealthy, you have to do something productive with that money, that is where you get the profits to cover the loan and interest.

So the ultimate source of profits on Wall Street is the real economy (though occasionally, i.e. when there is a bubble, the profits are based upon false valuations in the real sector). Profits come from people doing productive things with the loans they take out, and those productive things employ people and make the economy grow faster. Wall Street is a conduit to the real economy, it is not an end in and of itself, and when that conduit is not functioning properly - when money stops flowing through financial markets and intermediaries - productive activity is diminished and growth and employment pay the cost.

    Posted by on Wednesday, October 1, 2008 at 12:15 AM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (83)

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