Galbraith Against the Bailout
Jamie Galbraith says we don’t need this bailout. Instead, he proposes:
With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn’t, the FDIC has the bridge bank facility to take care of that.
Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund — a cosmetic gesture — and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary — as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can’t save everyone, and those investors aren’t poor.
Maybe.
36 Responses to “Galbraith Against the Bailout”
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September 25th, 2008 at 3:58 pm
The bailout is to get the banks lending, not to protect depositors. The preferred stock investment makes sense (and would be better than the proposed bailout), but the rest is not responsive to the situation
September 25th, 2008 at 4:11 pm
But for banks to be able to lend, they have to have depositors. While I’m not at all sure about Galbraith’s plan (it truly does not deal with the mortgage mess or the toxic sludge inhabiting non-bank financial intermediaries’ balance sheets), it would have the effect of attracting deposits (back?) to banks. (Deposit insurance, right now, would be a powerful attractor, I think.) This would then provide banks with more ability to make loans.
So the hwole thing is (indirectly) responsive to part of the crisis, the part in which commercial banks are implicated.
September 25th, 2008 at 4:14 pm
The preferred stock investment makes sense (and would be better than the proposed bailout)
Its’ pretty much what the “proposed bailout” consists of, no? I don’t know exactly in what form the equity position of the government will take in institutions that get cash, but my understanding is that the government will recapitalize the financial institutions in question in return for a) equity and b) debt securities.
September 25th, 2008 at 4:20 pm
Actually, it’s very responsive to the situation. Investment banks are considered at greater risk because they have no safety net for their investors. Insuring the banks investment should make other banks with the necessary capital confident enough to make the necessary inter-bank loans. Capitalization in the overall financial system is not the problem. Plenty of banks have the funds available for inter-bank loans, they just don’t have the confidence in American banking institutions. Of course, this plan won’t SAVE the banks in question from eventual losses that lead to bankruptcy, but should we really be interested in the survival of these firms?
September 25th, 2008 at 5:03 pm
So how does any potential bailout bill end up even working? I mean speed is supposedly vitally important. Congress is supposed to adjourn tomorrow. They supposedly (I have my doubts) have reached a tentative agreement between all? parties but the specifics are not yet hammered out.
When is the debate before the vote? Where is the chance to actually study the bill? Where is the chance to take any completed bill back to the congressional districts for input by constituencies? How long do we get to look at whatever it is?
I know that markets are panicked and credit freezes are supposedly imminent but WTF? People have been voicing yea and nay opinions about what at this point is a cloud of smoke.
Personally, I’d like to see the thing and hear the debate before there is a vote. How are we to decide if it’s a pile of crap or the best deal possible if we haven’t seen it yet?
September 25th, 2008 at 5:19 pm
Eliminating FDIC limits is tantamount to writing unlimited insurance policies. One could argue for raising the limits, but Galbraith’s suggestion of eliminating them altogether is foolish.
Also, I suspect the hedge funds aren’t particularly involved in this crisis. Didn’t several hedge funds make a ton of money last year betting mortgages would fail? Indicating they sold their mortgage-based papers months back?
September 25th, 2008 at 5:38 pm
Maybe.
Regardless of any plan, the bailout in question is aimed at getting banks lending by throwing money at them, and while that’s very nice for people on the receiving end, it will not work over the long-term (long-term here being about three months).
The point about saving the institutions is about the fact that if we let insolvent banks fail, we won’t have any banks able to do any lending, because it is very likely that they are all long-term insolvent, and we want to avoid the kind of contraction forced by a liquidity implosion.
max
['Which would be why you would nationalize them, if you were going to spend this much money.']
September 25th, 2008 at 5:46 pm
…and while that’s very nice for people on the receiving end, it will not work over the long-term.
Evidence? Not saying you’re wrong, but it seems to me if Bank XYZ’s capital is down, say, $900 million due to mortgage-related asset declines, and the government invests $900 million in said bank, other financial institutions should once again be willing to lend to Bank XYZ, because its balance sheet is now solid.
…we won’t have any banks able to do any lending, because it is very likely that they are all long-term insolvent…
Really? It’s “very likely” that all banks are “long-term insolvent?” Evidence? I was under the impression a good number of them are not only solvent, but are in a position to buy (BOA and Merrill, for instance).
September 25th, 2008 at 6:25 pm
Before banks do any more lending with this newly available money, shouldn’t we ban the kinds of bundled instruments that are causing so much of the problem?
There have been a lot of convoluted description of how these mortgages were bundled together, but the bottom line is that we, as homeowners are making long term deals, 30 years or more. But as soon as the deal is made it gets sold to someone else. So the salesman is really not interested in a long term relationship. The loan itself becomes a hot potato(e), nobody wants it.
The bailout is directed at these short term investors. The goal appears to be to prop up home mortgage values, which are overpriced, or were written without any equity so that the homeowner has no incentive to keep paying, and when they stop paying, there is no buffer to cover the default.
If these loans could not be resold (in the future), there would be no problem. The bank would never make a zero down loan. They would never make a loan where the insurance and taxes were not part of the loan. They would never make a loan where equity didn’t build up over the years.
September 25th, 2008 at 6:29 pm
Remember Y2K?
There was gonna be anarchy. All the lights would go out, food supplies wouldn’t get to supermarkets. Water systems would stop flowing.
Why?
Because computer systems would just kind of go haywire.
Which computer systems? Which power station is going to go off line and why? Nobody ever had an answer.
Imagine Y2K, with the solution being that the government should spend 850 billion to buy 150 billion worth of complex securities from the banks.
Now, the bozos who think “things would kind of go haywire” is an argument would be joined by the marketing and lobbying apparatuses of maybe the single most powerful industry in the country.
Forget about total meltdown. Which specific bank is going to stop lending on Monday if there is no intervention and why? Pick the bank you think is most vulnerable, and if you can’t answer why even one specific bank would stop lending on Monday given how things stand right now. And you can’t answer why one specific bank cannot make it to election day, or to the end of the year then your argument is “things kind of go haywire”.
Which of course is ridiculous. There is always a chance that “things kind of go haywire” there was that chance in August, there will still be that chance the day after the bailout. But if the bailout is not to prevent a specific event then it is giving away money.
What happens on Monday? What specific event are we trying to forestall? There has always been a chance that “things kind of go haywire” but if there is not a specific reason that at least one bank will stop lending on Monday, then there is no crisis. There is no reason to treat this as an emergency situation.
September 25th, 2008 at 6:38 pm
Well according to a congressional Republican I just watched on CNBC by Sunday night there will be a signed bill. Is there precedence for this?
And I ask again from anybody? Matt?
When is the debate before the vote? Where is the chance to actually study the bill? Where is the chance to take any completed bill back to the congressional districts for input by constituencies? How long do we get to look at whatever it is?
I know that markets are panicked and credit freezes are supposedly imminent but WTF? People have been voicing yea and nay opinions about what at this point is a cloud of smoke.
Personally, I’d like to see the thing and hear the debate before there is a vote. How are we to decide if it’s a pile of crap or the best deal possible if we haven’t seen it yet?
September 25th, 2008 at 7:02 pm
This proposal might work if our financial system still looked like it did in the 1920s. But it doesn’t.
It doesn’t even mention the problems of today.
September 25th, 2008 at 7:10 pm
Outstanding proposal…..why isn’t Congress thinking like this?
September 25th, 2008 at 7:18 pm
Wow! Too many people here assuming that those in charge are intelligent, open-minded, and working in good faith.
But the powers that be are not interested in your informed proposals. The Treasury just wanted to “choose a really big number,” remember?
The only answer to this bailout is NO. No, because those involved cannot be trusted. Any other *likely* outcome is preferable to giving our money to these people.
September 25th, 2008 at 7:53 pm
You really need to pay attention to, you know, FINANCIAL NEWS if you are going to post on this crisis. Most banks are setting extremely high interbank loan rates, virtually shutting down all ability to finance day-to-day bank operations (acquiring the capital necessary to give out loans to small businesses, new homeowners, new car owners, and college students). So far, you’re not seeing a huge drop in the stock market because everyone is convinced that the government will do something to solve this credit problem. If the government doesn’t do anything the stock market will tumble as average investors realize that companies will no longer have access to cheap credit.
The major difference between Galbraith and Paulson is that Paulson thinks the capital is there to solve this crisis, but there’s no interbank trust (banks don’t believe other banks are solvent). Just insure the investments, and everyone can go on loaning. Paulson thinks capital is fundamentally scarce, so the government needs to inject it into the market through buying these toxic mortgage securities. Otherwise, I’m not sure why he’d suggest such a dramatic solution.
WE NEED TO SOLVE THIS! Democrats are playing with fire if they think opposing any bailout would be a good, long-term political strategy.
September 25th, 2008 at 7:59 pm
WE NEED TO SOLVE THIS! Democrats are playing with fire if they think opposing any bailout would be a good, long-term political strategy.
Braden: do you have access to news websites? If you do, and you visit them, you might find that it is Republicans who are “playing with fire.” Democrats want to save the economy.
September 25th, 2008 at 8:34 pm
Jasper, you’re completely right and I modify my original statement to focus on some of us on the left, not elected officials, who are passing this off as some sort of scam. The Republicans have pretty much already written their obituary. I no longer consider them intelligent adults.
September 25th, 2008 at 8:43 pm
Braden- Republicans just decided to interject a new idea shortly after McCain’s stunt and maybe that’s a good thing because I still want to know:
If/when a bill is drafted-
When is the debate before the vote? Where is the chance to actually study the bill? Where is the chance to take any completed bill back to the congressional districts for input by constituencies? How long do we get to look at whatever it is?
I know that markets are panicked and credit freezes are supposedly imminent but WTF? People have been voicing yea and nay opinions about what at this point is a cloud of smoke.
Personally, I’d like to see the thing and hear the debate before there is a vote. How are we to decide if it’s a pile of crap or the best deal possible if we haven’t seen it yet?
If anything gets passed before October, Democracy is dead.
September 25th, 2008 at 8:50 pm
Nukev- All good points. For the record, I don’t like Paulson’s plan. I think Galbraith’s suggestion is much better. However, we need to treat this like a crisis for all of the reasons I listed above. Clearer heads need to prevail. Something needs to be done now, and then something needs to be done later so that this NEVER happens again.
September 25th, 2008 at 9:03 pm
Arnold Evans -
Go check out what LIBOR and the TED spread have looked like, especially before the plan was announced last Thursday. The lines on the graphs would look different but to finance types, it would look like an EKG flatlining.
And if you want specific examples, then Wachovia, for instance, would fail within a week. And they’re a very big bank. Hundreds of others would fail by year end.
When that happens, how do you think manufacturing companies and other types of businesses finance their operations? They don’t. No working capital, no money to buy raw materials, factories slow down or shut down. Workers laid off. GDP growth goes negative.
The financial sector is different from the tech sector or auto industry. It’s the lube that keeps the economy moving. It shuts down, and any business that isn’t funded totally from cash in the bank sees capital dry up pretty quickly (and there aren’t many of those). Those that do are next, because while they not need to borrow any time soon, their customers do, and if they can’t, they stop buying stuff.
September 25th, 2008 at 9:07 pm
Nukev, answers to your questions.
1. The debate is ongoing now. What do you think all these meetings on Capitol Hill and in the White House are about?
2. The text of the bill will be made available before a vote, when it’s actually been written out, just like Paulson’s original proposal and the congressional statement of principles have been.
3. “Input by constituencies”? Are you kidding? Most congressman have no clue what all this means. They don’t even know the lingo well enough to describe what’s going on in the markets. Taking “input” from the public, outside of economists, would be like consulting the public on how best to send a man to the Moon during the Apollo program.
We need there to be less wrangling among people with totally uninformed opinions, not more.
September 25th, 2008 at 10:18 pm
Re TH’s comment “Go check out what LIBOR and the TED spread have looked like, especially before the plan was announced last Thursday. The lines on the graphs would look different but to finance types, it would look like an EKG flatlining.”
————
Isn’t this hyperbole? Kinda like looking at the chicken entrails and saying “Better hold off on that German invasion , Caesar?”
The Overnight LIBOR was around 2 to 3 percent in the first two weeks of September, then spiked to around 5 and 6 percent around Sept 15 -16 and has since fallen back to 2-3.
But so what? It was running around 5 percent a year ago — for much of September 2007.
Plus it’s easily manipulated by banks lobbying for a handout — because of the honor system of reporting. See
http://dealbreaker.com/2008/04/beta_libor_is_dead.php
Why should we care if banks hold deposits –and lend thems to real businesses –vice lending them to other banks?
Yes — the creditworthiness of banks in general is now questioned. Good. The bad ones will fail and the survivors –who followed good practices — will grow as they take over the business of the failed banks. Again, good.
September 25th, 2008 at 10:30 pm
RE TH’s comment “And if you want specific examples, then Wachovia, for instance, would fail within a week. And they’re a very big bank. Hundreds of others would fail by year end.”
———-
But Wachovia is not failing because of adverse monetary conditions.
Wachovia is failing because its CEO made an extremely stupid acquisition and its Stupid Board of Directors let him. A $25 BILLION plus acquisition (Golden West) that it did NOT need to make.
Why should our taxes be ripped off to pay for the failure of Wachovia’s highly paid CEO to do due diligence??
See http://www.businessweek.com/magazine/content/08_24/b4088026392160.htm
Hilariously enough, the previous owners of Golden West, Herb Sandler and his wife, used part of the loot from the sale to finance this web site. Matthew doesn’t discuss that , for some reason.
September 25th, 2008 at 11:44 pm
Galbraith has a brain. The entire article is very good.
September 26th, 2008 at 12:24 am
TH- Maybe I give “constituencies” too much credit but there seems to me to be a fundamental difference between voting yes or no for A)Paulson Plan B)Dodd Plan C)Galbraith Plan or D)Some?? Plan. I see many people saying this is good or that is bad when in essence they have no idea what this or that Congress will vote on. Yet somehow I keep hearing that “a plan” will be approved before Monday. Is this normal?
My High School civics and memory of Schoolhouse Rock fail me.
September 26th, 2008 at 3:15 am
Congress has already committed to some form of support for banks. The questions are does it have to be passed by Monday and does it have to happen by election day. If the answers to these questions are no, then this is, by how I’m using the term “crisis”, not a crisis. If you think the situation is bad, and even want to call it a crisis, fine. But the point I’m addressing is the question of does a bill have to be passed during either over the weekend or during the campaign.
Braden:
Your link points to the highest LIBOR rate “since January”, with the LIBOR-OIS spread reaching the highest level “since 2001″. Ouch. Not a Great Depression. The terms for a $700 billion commitment have to be set over the weekend to fix that?
How do you get from “highest level since 2001″ to if the bailout is not done before election day, there will be a great calamity? It seems this is where you resort to “things kind of go haywire”. Even if the stock market drops, (why? there is already an expressed congressional commitment to support the banks) you still don’t connect that to the calamity you think happens if Congress doesn’t rush this bill. I don’t know if you realize it, but your argument is that things kind of go haywire in some vague sense. About the same as Y2K.
TH:
OK let’s say Wachovia is going bankrupt this week. I’d love to see an argument about why that would necessarily happen without a bailout, but if that’s what’s on the table, let’s deal with that.
This is not being sold as an effort to keep some banks from going bankrupt. A lot of banks can go bankrupt before the economy stops. This is being sold as an effort to prevent an imminent spiral towards an economic calamity.
If the spiral can be put off until there has been time to examine the options calmly then by the way I’m using the word “crisis” this is not a crisis.
I’d expect that given the cash streams Wachovia does have, it could be given enough credit, or sell enough of its equity for cash to the government to survive until 2009 for a fraction of $700 billion. If the problem is mass bankruptcies then not only is what is being proposed an indirect and inefficient way of preventing that, but simple measures can easily be put into place that will buy enough time to look at this issue reasonably, rather than in a panic.
Both:
We don’t have an argument unless you are saying simple and relatively inexpensive measures cannot protect the economy from doom over the next two months. Over these two months or the rest of the year, much better proposals can surely be produced than anything that has emerged so far under this pressure. Pressure I consider contrived.
September 26th, 2008 at 8:32 am
1) I think “hundreds of banks failing” is also hyperbole. In the sense that it lacks context — there are over 12,000 banks in the USA.
2) If you look here, you can see that banks vary greatly in creditworthiness: http://www.thestreet.com/tsc/ratings/screener.html
3) There are 325 banks rated E (very weak) and 2175 rated D (weak). But there are also 4408 banks rated C (fair) , 4322 rated B(Good), and 1058 rated A (Excellent).
I don’t see what’s bad about a few hundred of the E and D’s failing.
4) Is the above rating service reliable? I don’t know. It rates Washington Mutual as a D, which seems too high given the overnight news. It rated Indymac an E but that seems obvious.
5) I do know one of the banks rated A. It’s in a region buffeted by a boom and bust local economy (on a 20 year cycle from trough to trough.) Yet It has survived for almost a century. My father always used it because he remembered it lasting through the Great Depression when its competitors failed. He knew the President and knew what a conservative banker he was.
6) What the above screener does not do is provide the size of the banks — i.e., the amount of deposits at risk.
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