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A Practical Look At Why We Don’t Need a $700 Billion Bailout

posted by Lee, on September 25th, 2008 at 12:52 pm, in category Uncategorized

Listening to the congressional testimony over the last few days, it’s clear Hank Paulson and Ben Bernanke believe a $700 Billion dollar bailout is essential. Their central assertion is that the government must act because the private sector is incapable of buying that bad debt. I’ve heard several explanations for why this is the case, but none of them make a lot of sense:

1) Not enough capital in the private sector. This is clearly absurd. There are trillions of dollars in US and foreign companies sitting in cash. Berkshire Hathaway just bought a piece of Goldman yesterday for $5 billion. The private sector has so much cash they are buying treasuries hand over fist. There is far and away sufficient capital to buy all the bad debt in the private sector.

2) The debt is too complex and difficult to understand. I can understand this. These financial instruments are obviously very complex, and many companies holding them have been opaque about what they actually have on their books. Here’s the problem though: the government won’t be able to deconstruct these assets any more than the private sector will. Is it realistic to believe that a handful of federal accountants will be able to determine a fair value for trillions in assets, when the companies holding them, and millions of potential investors around the world, could not? Doubtful.

3) The market’s psychology is so broken, only a massive government bailout will prevent a major catastrophe. I understand this line of thinking, even though I disagree with it logistically. Bankruptcy of major companies like Lehman Brothers are painful and costly, not only to those companies but to many others. But it’s not the end of the world. Lehman went under, and the healthy segments of the company were immediately purchased and put to work in a productive matter. The existing shareholders will now fight over the remaining bad assets. If AIG went under (or companies dependent on AIG reinsurance), there is plenty of capital around to buy up the solvent and productive remains.

The two primary differences I see between the bailout and bankruptcy are:

1) With bankruptcy, solvent (well run) companies would be buying the productive assets, instead of leaving them in the hands of those that created the crisis in the first place.

2) Tax payers wouldn’t have to risk $700 billion dollars, or 5% of GDP.

At the end of the day, the only thing the government can do that the private sector can’t is print enough money to pay more for the asset than they are worth. In other words, tax payers would be taking an immediate loss on an investment so that companies holding bad debts can sell at a profit.

Every action in the economy as an equal and opposite reaction, the bailout is no exception. $700 Billion dollars will deflate the dollar and prolong the time it takes to truly liquidate the assets being held (the government will hold them and liquidate them at some later point in time). In other words, we’re trading quick and deep pain for long, protracted, slightly, less intense pain.

If this sounds familiar, it should; it’s what the government did during the Great Depression, and it’s what made the Great Depression last as long as it did.

There is topic on Veritocracy for this debate (Is The Bailout Plan the Right Move?), if you want to check out a number of other perspectives on the issue. Email me if you need a beta code.

Feedback? Write a comment, or e-mail the author at lee(AT)squawkingtech.com


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  1. on September 25th at 04:42 pm
    Ariel said:

    Sounds to me like you think that the assets the Govt will be buying are actually worth $0. Also, I think that at least part of the fear is that we have a Japan in the 90’s style problem. The banks limp along, niether acknowleging the full extent of the problem nor reentering the lending business. The result is a protracted stagnation.
    In fact, one could argue that even if the government overpays for the debt that the simulus that this will give to the economy and the subsequent tax revenue would more than offset this initial loss.

  2. on September 25th at 11:18 pm
    Lee said:

    The assets absolutely have value, and many years down the road the government might make a profit on them. But that’s an absolute best case scenario. They just as easily may lose quite a bit on the assets. The key point is that in the private market you buy an asset at a discount inversely correlated to its risk, and in case of the bad debt, the prices institutions want are not yet low enough to compensate for that risk. The only way the government can get institutions to sell this distressed debt, is by paying more than the market is willing to pay (in other words more than the value of the items). Thus the government is therefore transferring wealth (this surplus) from tax payers to private institutions.

    Now the argument that the global economy will benefit from preventing failures in the financial sector is very tenuous. There is a key difference between Japan and US right now, Japan of the 90s had a very positive net saving rate (in fact they had a glut of savings), the US has suffers from the exact opposite problem. The result of this bailout (and likely the next ones to follow) will be significant depreciation of the dollar, and rampant inflation. This serves as a direct tax on everyone, a tax that will have a proportionally large effect negative effect on the economy.

    The net result, is therefore (like most financial intervention) just a misappropriation of capital from efficient sources to non-efficient ones. This is the true cost of the bailout.