Flashback from last year.
In a pointed riposte to the Blinder-Zandi paper, Barry Ritholtz presents an inconvenient fact for bailout apologists (who grow more numerous and hysterical as the Great Recession grinds on): we were NEVER faced with the choice between A) Bailing out the banks, their executives and their bondholders at 100 cents on the dollar or B) Doing absolutely nothing while the world burned.
It was a false choice then and it's a false choice now. So why are PhD-wielding economists using this false choice as a basis for policy analysis? And why are the financial media letting them get away with it? Instead of joining this Idiots Parade, Ritholtz discusses the appropriate counter-factual: what we should have done instead of choices A and B above.
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We don’t have alternative universe laboratories to run control bailout experiments, but we can imagine the alternative outcomes if different actions were taken.
So let’s do just that. Imagine a nation in the midst of an economic crisis, circa September-December 2008. Only this time, there are key differences: 1) A President who understood Capitalism requires insolvent firms to suffer failure (as opposed to a lame duck running out the clock); 2) A Treasury Secretary who was not a former Goldman Sachs CEO, with a misguided sympathy for Wall Street firms at risk of failure (as opposed to overseeing the greatest wealth transfer in human history); 3) A Federal Reserve Chairman who understood the limits of the Federal Reserve (versus a massive expansion of its power and balance sheet).
In my counter factual, the bailouts did not occur. Instead of the Japanese model, the US government went the Swedish route of banking crises: They stepped in with temporary nationalizations, prepackaged bankruptcies, and financial reorganizations; banks write down all of their bad debt, they sell off the paper. In the end, the goal is to spin out clean, well financed, toxic-asset-free banks into the public markets.
Thus, Bear Stearns is not bailed out by the Fed. Instead, under my scenario, the FOMC chair tells JP Morgan’s CEO:
- “You have 9 trillion dollars in exposure to Bear derivatives. Instead of guaranteeing you $29 billion for a risk free takeover, we will start preparing a liquidation plan for Bear. And given your exposure to them, we best plan one for JPM too. And if you don’t like that, you can kiss our ass!”
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