Mathew Yglesias discusses a dispute about whether recovery from the recession would have been faster if we had provided more help for households, and less help for banks:
This gets us to the actual dispute. Team Tim [Geithner] would say that they're trying to create a well-capitalized banking system in order to bolster the broader economy. Team Neil [Barofsky] counters that the broader economy would be better-served by a policy that imposed steep losses on banks and instead repaired household balance sheets. Beneath all the anger and accusations and counter-accusations is a fairly wonky policy disagreement about the relative importance of household balance sheets versus the credit channel to laying the preconditions for growth.
Here's my take (from December 2010). As others have noted, we needed to help both banks and households, and it didn't have to be one or the other. But there was no need to bail out banks directly, at least not on the scale that it was done, banks could have been helped indirectly by helping households:
...recovery from these “balance sheet recessions” is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy. It takes a long time for households to recover what is lost, and the recovery will be slow so long as this rebuilding process continues. Fiscal policy attempts to restore the lost aggregate demand, and that is important, but it does very little to directly address the household balance sheet issue.
The same cannot be said about bank balance sheets. The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.
But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.
When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government’s balance sheet as a means of offsetting the deterioration in the private sector’s financial position. But we shouldn’t just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We’ll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.
To be more concrete, the government could have given households help in the form of a voucher that could only be used to repay loans (e.g. mortgage, student loan, or credit card debt incurred prior to this program). Banks still get the money they need to stay liquid and solvent, but households get help at the same time (an alternative, and what we essentially did, is to write off the loans and foreclose, etc. on households, then give the banks money to offset the losses). There are still political problems associated with using taxpayer money to bail out people with bad credit, so how the program is designed would be important (for example, there might be less objection to helping people who are having difficulties due to job loss from the recession, but are otherwise decent credit risks), but the point is that helping banks does not require handing them money. The help can be funneled through the household sector allowing both sets of balance sheets to be rebuilt at the same time.
[Brad DeLong also comments.]