Let ‘em fail?

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“Let them fail!” As people get a more in-depth look at the (at least) $700 billion bailout of the nation’s biggest financial institutions, it’s a cry that is growing in volume. Today, the government bosses who were responsible for getting ahead of the financial crisis — and clearly didn’t — went to Capitol Hill to sell the plan to increasingly skeptical politicians, who also were in office while the crisis grew.

“Rage Sweeps over Middle America,” the Times of London blared today.


Richard from Anchorage, Alaska, was typical of many when he wrote on CNNMoney.com: “NO NO NO. Not just no, but HELL NO.”

Anna from Denver wrote on the same site at the weekend: “This is robbery pure and simple.” Claudio from Plainville, Connecticut, added: “It’s our money! Let these companies die.”

It’s settled, then. Let them die rather than pass along the cost of keeping them on life support, which — by the way — is $5,354 per taxpayer, and still — depending on who you believe — may not work.

The dialog around the issue this week is very much like the one that surrounds the war in Iraq. It doesn’t matter anymore how we got there. We’re there. Now what are our choices?

What does “let them fail” look like on Main Street?

“Jobs will be lost, … our credit rate will rise, more houses will be foreclosed upon, GDP will contract, … the economy will just not be able to recover in a normal, healthy way,” Federal Reserve Chairman Ben Bernanke said today.

Megan McArdle, writing on The Atlantic’s Web site, suggests the damage isn’t limited to the fat cats and stupid consumers. She says companies — like yours, perhaps — that used credit sparingly, will go from a short-term bad economy, to a long-term bad economy.


The problem is, the effects of really rapid contractions don’t last a couple of months. They last years. Can your company withstand the bankruptcy of some major clients with large outstanding accounts? How many people will it have to fire if its order book drops 40%? Can it cover its fixed expenses even on half staff?

I talked this afternoon to Gary Krueger, the head of the Economics Department at Macalester College about how “let ‘em fail” would impact you and me. “You’d drastically reduce the size of the financial sector. There’d be a panic. A good chunk of our savings is foreign. They’d be less willing to lend in the future, they’d stampede out of the dollar-dominating (financial) instruments, he said.”

So?

“You wouldn’t be able to get a mortgage, the value of a dollar will drop, the price of oil and gasoline will go up,” he said. Russia in the ’90s provides the best example of an economy without a functioning credit market. “It wasn’t pretty. People lived hand to mouth,” he said.

Student loans? Forget ‘em under “let ‘em fail,” according to Krueger. “If you had to pay for things hand-to-mouth, you could afford to take one class a year every year and 32 years later, you’d have your degree. Or you could use the credit markets to graduate in four years and begin taking advantage of it,” he said.

Another option, he said, is one employed by Japan in the ’90s in which the government would occasionally intervene in the stock market, and make balance sheets look better than they really are. The economy didn’t grow for 15 years. “It’s slow water torture and the government creates fiscal stimulus with low-rate-of-return projects. I just talked to a friend who was in Tokyo and he says there are post offices in Japan the way Starbucks is here,” Krueger said.

Part of the reason for a “let ‘em fail” recommendation by people in “Middle America” may be that financial calamity takes a couple of years to work its way to Main Street. The stock market collapsed in 1929 and the depth of the Great Depression was 1933. The savings-and-loan crisis hit around 1989, and America went into a recession in 1991.

No matter what “American savings has to increase and consumption has to fall,” says Krueger. The savings, however, will come involuntarily. You and I simply won’t be able to afford to spend money because the credit will be too tight to make us want to.

What does Krueger’s gut tell him? “In Bernanke I trust,” he said, even though he doubted the Fed chairman earlier this year when he lowered interest rates, a move which seems now to have been the right call. “He’s a student of financial crisis,” Krueger says.

The best advice for average people? Krueger says don’t hit “update” on your Quicken program. “Go buy an ice cream instead.”

  • one dumb consumer

    My company and the ones my friends own are in great shape and actually hope that there is no bail out because our competitors we benefit, not us.

  • http://erikhare.wordpress.com/ Erik Hare

    If you take out the federal budget deficit, the bad loans, and inflation, our economy has not grown for at least 7 years – and has contracted slightly. We have already had something like a Japanese intervention to save the Big Boyz (details on my blog).

    The basic “moral hazard” is this: I had a business, allsaintpaul, that failed. I still owe money on it to Wells Fargo, and will for some time. Wells Fargo gets upset if I’m even late with a payment, let alone not able to make one. But if Wells Fargo owes money to someone? I’m apparently on the hook for that, too.

    Bad business choices happen. Some level of forgiveness has been part of our system since we decided to do away with Debtors’ Prison and have liberal bankruptcy laws. BUT – will we emerge from this stronger, with a better functioning and properly regulated system, or not? I can stomach the “moral hazard” if it works in the long term.

    Over the last 7 years, we’ve been papering this crisis over with T-Bills when we should have been regulating it appropriately. A bailout without appropriate controls is just more of the same. In that case, we probably would be better off letting ‘em fail.

  • brian

    I like the Iraq comparison Bob. It is very similar.

    As much as I don’t like the idea of bailing out the people that got us into this mess, I’m not willing to live with the consequences of not bailing them out.

    I still voted no above, since it said “As currently structured.” I think a final bill should include help for homeowners, and not give absolute power to Henry Paulson.

  • MR

    I should have voted “I’m not sure” in the poll, because it’s not that clear exactly how the current bailouts are going to be structured.

    I have three mildly connected thoughts on bailouts:

    I think that there’s a bit difference between “not letting firms fail” and “keeping firms afloat with the same profit margins and levels of executive compensation.” A bailout package should lean more toward the former, and have the teeth to enforce that standard.

    Now is the time for the government to set long-term regulatory policy, and tie those changes to the bailout loans.

    Bailouts should be structured in such a way that they’re not just government grants. They need to be loans, with an expectation that the government will be paid back.

  • bsimon

    So far as I understand it, the so-called bailout is designed to keep the credit markets solvent by transferring bad debt from lending institutions to the gov’t.

    Why wouldn’t it make more sense to make the $700 Billion available for lending directly from the gov’t, in the event that normal credit market seize up?

    In other words, let the free market work, in terms of punishing businesses for poor decision making processes. If enough of those businesses fail to take out the credit markets, the gov’t steps in as lender of last resort.

    Seems like in either case, a new gov’t bureaucracy will get created to manage the loans – why not stack the deck in taxpayers’ favor by creating new, good debt, rather than existing bad debt? As poorly managed companies fail, surely new companies will step into the vacuum & enter the credit market. Perhaps the news, today, that foreign banks are buying up US banks is indication that exactly that is already happening.

  • Joel

    I also think something needs to be done, but not as currently written, where those who got us into this mess get off scott free and there is no oversight of Paulson or Bernanke.

  • sm

    Banks that make mortgage loans should be forced to keep them, not sell them. Then they’d pay more attention to whom they were lending. Isn’t this how things used to be?

    And what’s all this nonsense about including credit card debt and car loans? From an AP article:

    “In an expansion of its original proposal, the Bush administration is asking for broad power to buy up virtually any kind of bad asset – including credit card debt or car loans – from any financial institution in the U.S. or abroad in order to

    stabilize markets.”

    Is there any incentive not to default if the poor (literally) taxpayers are left holding the bag? Step right up, everyone, get in line for your handout. There will always be opportunistic shysters whether they inhabit financial markets or circle over the government bailout. Just accept it, that’s capitalism.

    Executive golden parachutes are a diversionary red herring. There’s not enough money there to be consequential. The question is what course of action will hurt the economy and the public the least.

  • Bob Collins

    //Banks that make mortgage loans should be forced to keep them, not sell them. Then they’d pay more attention to whom they were lending. Isn’t this how things used to be?

    Here’s a question I posed on Twitter. To what extent is the Community Reinvestment Act, which essentially outlawed redlining. In 1995, it was toughened to increase the number and size of loans to small businesses and low and moderate income borrowers.

    Morally, that makes a lot of sense, but mainstream banks vehemently opposed the legislation and were subsequently portrayed as racist, as opposed to fiscally prudent.

    For that fact alone, doesn’t the same federal government thus have a responsibility not to adopt a “hey, it’s YOUR business pal, you figure it out” response (or non response as the case may be).

  • Mark Gisleson

    Bob, the Community Reinvestment Act was passed in 1977. Could you explain why it didn’t cause this crisis for Carter, Reagan, Bush I or Clinton?

    This scandal didn’t happen because po’ white bankers were forced against their will to make loans to no ‘count city people. This debacle is the result of extraordinarily greedy banks preying on their customers. $33 charges for being $10 overdrawn? And these are the people asking for a handout?

    Our financial institutions became infatuated with themselves, grossly overpaid themselves, and now, like whiny babies they want Uncle Sugar to bail them out.

    I like Bernie Saunders plan to slap a 10% surcharge on those who make over $1,000,000 a year. That alone would pay for most of this bailout, but best of all we’d be up $600 billion if we raised taxes on the extremely rich (who’ve been undertaxed compared to working people) and then refused to bail out the greedheads on Wall Street.

  • Bob Collins

    I had a nice long dialogue which I lost because I hit backspace by mistake and I don’t feel like retyping it all, Mark. But I’m obvioiusly not suggesting that the crisis is the result of the CRA (which had its focused mostly set in ’95), but that the government has used banking laws to direct the lending practices (some lending practices) of banks so the whole “hey, YOU’RE the ones who lended the money” doesn’t really hold a heck of a lot of water in total, does it.

    But the big thing is I was trying to do the math on Bernie Sanders proposal — which hasn’t got a prayer of ever passing so why pretend it does — and I can’t make the math work. But I think it’s because there’s too many zeroes.

    BTW, I mentioned via twitter the other day that one thing I’d like to see if we’re going to go a bailout route is a simple directive to banks that says you will NOT clear the big checks first, so all the little checks bounce at $39 per.

    So that was all fun and all, and now we’re back to where we started: What’s the plan for keeping the little people from getting hosed on this whole deal? Great, we hate rich folks, I get all that, but what’s the solution that actually has a chance of seeing the light of day?

  • Mark Gisleson

    I’m glad you’re not saying that, because Neal Cavuto IS saying that and more, and now there’s a lot of nonsense flying around the Republican side of the blogosphere that the whole system crashed because banks were forced to make loans to blacks and hispanics.

    Bob, for twenty years I typed salary histories up for resume clients, and our compensation system has been completely broken for at least that long. These people set their own salaries, bankrupted the system, and expect to be bailed out. While doing so they shafted their own employees and shareholders.

    The systems was gamed and the worst offenders were the most overcompensated. I don’t know if Bernie’s math is right, but if we don’t start making rich people pay their FAIR SHARE of taxes, we have no hope of ever straightening out our economy.

    No bail out is preferable to sticking the taxpayers with the tab for yet another financial meltdown.

  • Bob Collins

    I understand the sentiment, Mark. The question I have, however is: Is it preferable?

    If the credit market were to collapse and, to reuse the example, you can send your kids to college, wouldn’t the fact that some CEO is out of a job be cold comfort?

    Or is the feeling that the credit markets would stay intact if we let them fail?

  • Alison

    My CEO out of a job would not be comfort to me. He’ll be fine if he never works again. He made 20 or 30 times as much this year as I’ll make in my lifetime at his company.

    I’m just glad that Congress finally seems to be standing up to the power grabs of this administration. With a couple of months to go, they finally figured out that they didn’t have to give W everything he wants when he wants it.

  • Elizabeth T

    Plan A:

    have the government simply buy the failing banks. Don’t lie to the public about capitalism. Giving them money for this is socialism. Admit it, and simply nationalize the banking system. If the government “buys” the bank, then the government will at least own it afterwards. Translation: the taxpayer will actually have something capable of making money as a return for investment (read: buyout), not just another line-item debt.

    Plan B:

    let them fail. Admittedly not such a great idea, although it is in line with die-hard Capitalism

    Plan C:

    Find someone else to buy the banks. Maybe some shiekh in the Middle East? Maybe the Chinese government? Bill Gates? I guess this is sort of the alternative of Plan A. Rather than the American People owning the banks, we can just sell our souls to the rest of the world at junk-bond prices. Not that I want to, but it is an alternative.

    Personally, I like Plan A. I would say “well, I’m not an economic whiz”, except the idiots running Wall Street apparently aren’t either.

    My objection isn’t completely about the money into the company. My overwhelming ojection is whether the idiots who ran the banks into the ground are going to benefit from this “bail out”. The company needs a hand, well, okay. But the people who created this situation by astronomically bad management …? They simply need to be fired. No pension. No benefits. No severance package. Do Not Pass Go, Do Not Collect $200 million.

    If I made decisions like these, and caused this impact to my employer, I would be out on the street faster than you can say “bail out”. Now that is something you can take to the bank.

  • Mark Gisleson

    I think what we’re seeing here in the comments is the fact that average Americans remember all too well the astonishing arrogance of Wall Street CEOs who insisted they were EARNING their huge paychecks.

    Hell, I would have run their firms into the ground for free!

    Decision makers have decided that decisioneering is soooo hard that top decision makers must be grossly overcompensated, even if it means shipping half the company to China.

    The truth is that decision-making is very easy when, like our President, you assume your “gut” is correct all the time.

    No solution to this crisis will be acceptable to most Americans if that solution does not involve going back in time and stripping these criminals of their ill-gotten loot. As it stands now, it’s like the FBI letting Dillinger go free because money, once stolen, belongs to the thieves.

  • Citizen Bob

    Let them fail! In a freemarket capitalist society businesses fail all the time. Banks are not immune to the effects of mismanagement. The Paulson “plan” falls short of providing a clear and definitive plug in the leaking dike. I haven’t read anything describing a way to prevent the overleveraging events from cropping up again. Where did all the money go? It doesn’t just evaporate?! If we have learned one thing its, follow the money. Right now, the Treasury and DOJ should be following the money trail instead of ripping off Joe SixPack to save Hanks pals.

  • Doug

    Let ‘em fail. I like bsimon’s idea, why can’t we use $700 billion to create a new bank with no toxic waste that can take up the slack doing all that important lending? In fact, the new bank could rake in deposits since it’d be 100% goverment-backed, and right now everyone’s rushing into 3-month treasuries at 0% interest. The new bank would be awash in deposits if it paid even 1/2 % interest wouldn’t it?

    I agree that we need to keep the credit markets working but there’s gotta be a way to do it without any of our money going to these greedy banks and hedge funds. I would rather take a hit on my 401k than give them a dime. I betcha 90% of the stocks in our index funds would bounce back soon enough.