Tuesday, September 30, 2008

Some common sense thinking on this horrible bailout plan.

From CNN.com:

Commentary: Bankruptcy, not bailout, is the right answer

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth


Bakonewbie said...

Makes sense. One thing that I have been thinking and writing ot congress and senate is the option of a gov't insured type of loan to get people out of their liar loans and ARMs.
The catch would be to make those liar loans into fixed 40 and 50 year terms. They are not ideal BUT people would still have to pay back their original amount, their payments would be lower and it would allow them to weather the market and then sell/refi later.
Also, many of these liar loans seem to have gone to young people. So a 40 year term for a 25 year old is not the end of the world.
At least it seems like an option that does not soak the taxpayers or give freebies to idiots.
Why is no one talking about this? Am I missing something?

Ben Franklin said...

BTW, a shout-out for our Representative from California, Kevin McCarthy (R). He voted against the bail-out bill BOTH times it was presented, as he recognized there was no "emergency" (it was being pushed down the throats of all of us with threats of martial law if it didn't pass, etc), but more importantly, represented a HUGE waste of taxpayer funds.

He realized the final version contained elements that were helpful (e.g. raising FDIC limits), but knows there were ways to skin the cat without resorting to such extreme measures.