Like most statists and interventionists, former Treasury Secretary Henry Paulson raises the economic equivalent of monsters under the bed when justifying more government. Here’s a blurb from a story about his recent testimony on Capitol Hill:
…former Treasury Secretary Henry Paulson on Wednesday defended his decision to complete a $182 billion bailout of American International Group Inc., arguing that the unemployment rate would have risen easily to 25% without the bailout. “If the system had collapsed millions more in savings would have been lost,” said Paulson, who was Treasury Secretary at the time of the bailout, at a hearing. “Industrial companies of all size would not have been able to raise funding and they would not have been able to pay employees, this would have rippled through the economy.”
For the sake of argument, let’s assume he is right and that the economy would have collapsed without huge amounts of money being pumped into the financial system. Does that justify Paulson giving money to his friends on Wall Street? Not at all. The crowd in Washington could have used what’s known as the FDIC-resolution approach, which would have resulted in the government paying healthy financial institution to take over the insolvent ones. In effect, this is what happened during the savings & loan crisis twenty years ago. It’s not an ideal libertarian solution since tax dollars are pumped into the financial system and there is some degree of increased moral hazard since consumers/customers have less reason to monitor the safety and soundness of the banks they patronize. But the FDIC-resolution approach has one enormously good feature, at least compared to the Bush-Paulson-Obama-Geithner bailout: Bad banks are shut down, meaning that shareholders lose all their money and senior managers lose their jobs.
There was no justification for bailing out the institutions that went under water. To the extent a system-wide collapse was a real possibility, the FDIC-resolution approach would have worked. Indeed, it would have worked much better since the economy would not be plagued by the zombie banks that are only alive because of handouts from the Treasury (similar to what happened in Japan). But politicians instead chose the approach that was bad for the economy, but good for raising campaign cash and increasing the power of government.
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Back then Bob Murphy had a great column at Mises.orgThe Great Bank Robbery of 2008. I especially love the graphics of the story.
I don’t think that it is an accident that Paulson and others mix broker-dealers like Goldman Sachs and Lehman Brothers with commercial banks like Bank of America and Citibank.
There are thousands of commercial banks, though JP Morgan Chase, Bank of America, and Citibank held nearly half of the total assets of the commercial banking system.
Citibank had almost the same problems as the broker-dealers, like Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley. JP Morgan could have had the same problems, but didn’t. BoA bought into the problems by purchasing Merrill Lynch.
The Broker Dealers have no deposit insurance, they had no access to borrowing from the Fed, and there was no chance of FDIC resolution. It was bankruptcy for them.
But, “everyone” calls those broker dealers “banks,” and the bankruptcy of those banks is being identified with the failure of the thousands of commercial banks.
No, the thousands of commercial banks, and even the big three, can borrow by issuing insured deposits. They can borrow from the Fed. And can be reorganized by FDIC.
The amount of deposits in the commercial system depends on monetary policy. The question of whether or not industrial firms can borrow money depends on whether or not commercial banks can again figure out how to use deposits to fund commercial loans, rather than selling loans.
Would it be more costly for firms to borrow? That all depends on how much the banks end up paying depositors.
It really does come down to bailing out Wall Street.