As President Obama promised Monday to halt the $165 million in bonuses to disgraced financial wizards at insurer AIG and announced a new $15 billion government lending program for small businesses, ordinary people were asking a simple question: Why not give the money to them to buy a new car or pay off a mortgage or just deposit in a bank?
Not so fast, experts say. Although it sounds like a great idea, writing checks to people would not prevent more bank failures and much worse economic fallout.
On its face, the idea seems reasonable. Taxpayers are spending $700 billion to rescue banks and nearly $800 billion on the stimulus package. That comes to $1.5 trillion, which doesn't even count the trillions in emergency lending undertaken by the Federal Reserve.
If Washington had simply taken the $1.5 trillion and cut a check for each of 140 million U.S. workers, each would get $10,714.29.
With such a sum in hand, they presumably could buy a new car, or pay off credit card or mortgage debt, or go to Nordstrom, or vacation in San Francisco, or simply deposit the money in local Citibank branch or some other foundering institution.
But that probably would not prevent a major financial institution from failing and making today's economy even worse.
"Because we live in this world of an elaborate pyramid of credit, we are now in this bizarre position where the U.S. government is bailing out German banks but not bailing out ordinary mortgage owners in the Central Valley who made the equivalent of bad decisions about who to invest with," said Gregory Clark, an economic historian and chairman of the economics department at UC Davis.
If AIG had defaulted on its obligations to creditors, its credit would have been damaged, causing cascading defaults throughout the financial system that most economists believe would have turned the Great Recession into the Great Depression II.
Instead, the government has spent $170 billion rescuing AIG, which in turn paid money to European banks Societe Generale and Deutsche Bank and to those poster children of the financial meltdown, homegrown Goldman Sachs and Merrill Lynch. Even California got back $1.02 billion parked at AIG.
Strings attached
Moreover, the government rescues have strings attached that might spook anyone - including the obligation to pay the money back and the threats and meddling that are the right of any owner.
"We're not actually giving the money to these companies," said Dan Seiver, a finance professor at San Diego State University. "It may seem that way, but we're either lending to them or buying shares of the company. We own 80 percent of AIG and pieces of all the major banks. I don't think most Americans would like to get $10,000 from the government and then have to pay it back or they would own a piece of you."
Parts of the $787 billion stimulus package are actually giving cash to workers: a rebate on payroll taxes that will soon begin appearing as small increase in weekly paychecks, more unemployment insurance, more aid to students and the like. The billions sent to states prevents some workers from getting laid off, and other investments in roads, rail, electricity grids and other projects will trickle down into people's pockets as more people work and spend.
House of cards or finely wrought gold chain, the modern financial system is such that if one big piece fails, the rest can come apart.
No one, least of all Obama, wants to risk repeating the Bush administration's decision last fall to let investment bank Lehman Brothers fail, setting off the financial panic of mid-September that quickly resulted in an economic contraction.
'Pyramid of credit'
In the modern economy, Clark said, a "pyramid of credit" stands on a small amount of actual money. That credit constitutes the economy's money supply. It "depends on all of these loans that people are making to each other, and basically if those loans seize up, there's a huge shock to the money supply in the modern economy and demand would actually collapse."
That is about what happened in the Depression, when thousands of banks failed and unemployment reached 25 percent.
Last fall's $700 billion rescue is widely believed to have short-circuited a complete meltdown in credit markets. As it was, the damage pushed the economy into a severe recession.
If the rescue money instead went to individuals, and everyone "saved it and paid back some of their debts, there still would be some individual financial institutions in a lot of trouble," said Brad Setser, a former Treasury Department economist now at the Council on Foreign Relations. "We aren't bailing out banks so much as everyone who lent money to the banks, and ultimately that is all of us."
European banks
It turns out that many large European banks were financing themselves in part by borrowing from U.S. money market funds. "So we're bailing out European banks," Setser said, but "indirectly we're bailing out some Americans who had some of their savings in money market funds."
Moreover, even if everyone received $10,000 and deposited it in a bank, there is no guarantee that the banks would lend it out. Like workers, they are trying to rebuild their capital.
At this point, banks also are restricting loans not necessarily because they are weak, but because 4.4 million jobs have been lost, demand for goods and services has contracted, and trillions of dollars in real estate and stock wealth has evaporated, leaving fewer creditworthy borrowers and less demand for loans.
The question is how to protect taxpayers from ever again having to rescue companies like AIG. For most, that means more regulation and smaller institutions.
For the past 20 years, "there was the sense that we should have free markets, that we have sophisticated investors who will not to take positions which are ridiculous, and that we should open the financial system, we should let people invent new types of financial instruments, it will all be for the good," said Clark.
The idea was that sophisticated investors would see the risk in an AIG, beat down its stock price and force the companies to behave differently. That indeed happened, but far too late.
"Market discipline just didn't work," Clark said. "It was just too complicated. Even experts at the Fed had no idea how complicated these interconnections were, how much risk there was."
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/03/17/MNR516GA5N.DTL&tsp=1User comment... and I agree with it.. Thank You
maeninaeidethea3/17/2009 6:31:13 AM
That familiar saw about no-one-could-have-seen-this-coming is just baloney. People made clear warnings that anyone could understand. Hiding risk in mashed-up equities was not done my mistake - that was a crime. Even before that, pushing cheap money and promising the American dream to people that could not afford to pay it back was also criminal. The who-me? pretense that there was no bubble when Greenspan and others were pleased with themselves for producing a bubble was at least disingenuous. As long as there was money to be made the most powerful US banks; most respected CEO's, money managers, and other MBA-types rode the wave. They knew it was coming, they just didn't want the wave to crash on them. Incredibly, while millions of decent working people have lost their jobs, many of the culprits are still in their jobs getting away with it; and, getting away with murder if you count all the suicides.
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