The financial crisis. Let me show you it

[clayfoot]

This American Life did a marvelous job of explaining the subprime mortgage meltdown, and they're working on a followup to explain the current crisis. I think that followup airs at the end of this week.

Comments

[t_rex]

Thanks! I understood pieces of the problem, but couldn't quite string all the pieces together.

So, what I want to know is this. Would it be better to let the market correct itself, over time, rather than do this bailout thing to get the economy going again? It would hurt worse, perhaps, but in theory the economy would be stronger than before once it recovered. Seems like a bailout would get things moving again, but the underlying issues would remain in large part.

This isn't a question for you, necessarily, but it would be nice to hear your opinion if you have one. Maybe NPR will explain that part, too.

[clayfoot]

The honest answer even from the experts: Nobody knows. Temporary government measures (like the stimulus package earlier this year) usually don't work. They create a temporary "bump" in the overall trend, and then the economy continues the trend as before. This bailout, as proposed, is so big that it might actually prevent a collapse. Then again, there may be no collapse, package or no package. If we do bailout these big financial firms, then we accept that some private institutions are essentially too big to be allowed to fail, and we enter a new era of American politics and economics. I, too, am looking for expert opinions on what to expect.

[t_rex]

>If we do bailout these big financial firms, then we accept that some private institutions are essentially too big to be allowed to fail

I'm not comfortable with the precedent that would set. If you are "big enough", it doesn't matter what you do, or how lousy your business practices may be. The government will always bail you out.

[clayfoot]

--Even worse: As soon as you attain that status, the government won't even allow you to get close to failure. It will intercede before you're actually in trouble. This is something like how we treat public utility monopolies, now, only it will be for companies that ostensibly have competitors that could do business just as well or better.

[ozy_y2k]

The precedent's already been set, though. It was set decades ago, when the government under Reagan bailed out Continental Illinois under the theory that the bank's failure would be too big for the overall economy to absorb.

That precedent was reiterated just earlier this very month when the government bailed out AIG.

[clayfoot]

Continental Illinois is a better example than AIG. At least AIG got a loan, and was left in possession of its "illiquid assets." With the current package, the government proposes to buy up those assets, and transfer the problem of what to do with them to the government. Since we have some institutions that were bailed out with loans (like AIG) and some which were allowed to fail (like Bear Stearns), we still have an opportunity to let the investors keep their bad investments, and perhaps allow the market to choose a new set of big players who won't bank on the federal government to bail them out for taking their own foolish risks.

[ozy_y2k]

Well, yeah, it was a loan, but it was a loan which was repaid, in part, by warrants for almost 80% of AIG stock which were issued to the Federal Reserve. So that makes it look a lot more like an equity buyout. Granted, the Fed may never EXERCISE those warrants (and probably won't), but functionally it basically bought the right to own a huge stake in a private company, which to me smells like a bailout-of-sorts.

[clayfoot]

Absolutely right. Quite out of order in a free market economy. But... even a loan backed by (potentially useless) stock is better than buying up (potentially worthless) securities, and turning the government into the world's biggest mortgage holder. Somebody has figure out what these mortgage securities are really worth, and these big financial institutions are the best equipped to do that. At least, they have a financial incentive to figure it out and get it right.

I realize the risk: With banks loaded down with securities they can't value and can't sell, they still won't be able to get liquid enough. We'll face ten years of stagnant growth, just like Japan, because nobody can borrow or lend enough money to grease the economy. We're so much bigger than Japan, and so much more rich in land and in natural resources, and so much more service oriented, that I don't know if it's as great a risk for us, but I see it, I see it...

[clayfoot]

I caught part of this explanation at the end of last week. I guess I kinda track with his reasoning on opposing the bailout, at least as currently drafted.

Bailout Could Deepen Crisis, CBO Chief Says
Asset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells Congress