Was the Banking Bailout of 2008 a Bad Move?

by fwhagen Thu, 16 June 2016

Ok, I am not an economist.  I think I might have been if the computer industry didn’t exist, but I am not.  I'm not a historian, either.  This is all my personal opinion.

In 2007 – 2009, Trillions of U.S. Dollars were spent to “bailout” the U.S. financial system.  Many, many people thought this was a terrible way to spend taxpayer money in order to save banks, insurance companies, and mortgage brokers.  Most still do.  Sure banks make mega-millions in profits and few people hate mandatory insurance as much as I do.  “Let ‘em fail!” I have heard many times.  “Why do my taxes have to go to pay off fat-cats.” as well.  “Where’s my bailout?” was my favorite.  (Yes, sarcasm on my part.)  But was it so bad?  I’m not so sure.

Let’s go back a few years.  1929:  The start of the Great Depression.  Ask yourself, what caused the Depression?  If you’re like most Americans, as I was not so long ago, you will answer:  The Stock Market Crash of 1929, Black Tuesday.  But that’s actually not really true.  It was a trigger, certainly, but not the cause.  The thing that really pushed everything off the cliff was panic.  Panic over the banking systems.  People no longer trusted the banks and wanted all their money out, and now.  Back in those days, nearly all money was real.  And since much of it was tied up in investments, loans, etc., when millions of customers showed up and wanted their money, the bank locations didn’t have it.  Obviously.  That is still true today.  You wouldn’t expect your local BofA to have $Billions in the vault at every location.  So when bank clerks said, sorry, we’re all out, people freaked.  Of course, nobody panicked and paid back all their loans too, right?  So banks crashed too.  And suddenly, because the dollar was tied to the Gold Standard, and there was no money, the price of gold fell.  Less cash means the amount someone is willing to pay for it falls as well.  This had a larger cascading effect that impacted the entire world economy, which is the reason why most governments have rejected tying money to physical commodities.  And thus started the Great Depression.  BTW, inflated real estate pricing was a primary factor back then too.

Back to today, almost.  We could go back to the ‘90s and note that the Clinton administration (hopefully, the ONLY Clinton administration), persuaded Congress and/or the banks to make it easier for less… (uh, hard to find a good word to go here.  “capable” comes to mind) …qualified (?) people to get mortgages.  And sub-prime mortgages became a thing.  Banks were forced, or coerced, or agreed, to give out loans to people who were traditionally considered high-risk.  This radically increased demand in the housing markets.  And prices began to rise.  I was actually very lucky to get in early with a mortgage I should never have qualified for, but I made good on it.  After 10 years or so, the peak hit and now some lendees were unable to keep up with their really bad contracts and started to default.  This is normal.  Pricing started to correct, and more houses were on the market.  This is also normal.  And then there were more defaults and prices fell and banks were left with properties with loans that were much higher than the value of the housing.  And the bubble burst.

So in 2008, there are many banks that are left with assets they are unable to liquidate and obligations they can’t meet because of it.  So what do you do?  Let them fail?  Sure, why not.  I certainly never bought the “too big to fail” argument anyway.  But consider this: 

Let’s say I have $100,000.  What is my net worth?  Easy, $100k.  Now, you would like to buy a house, so I lend you $100k because I know you have a job and will pay me back with some interest.  So, what is my net worth now?  $0?  Well, no, you owe me $100k, so technically that money belongs to me.  $100k?  Actually, no, I expect that you will pay me interest on that, so I should be ahead in the end, and if you don’t pay, I get the house and whatever you paid so far.  Looks good for me, right?  Ok, now let’s say that you wanted to buy a house for $150k, but I only have $100k which is mine, but I am holding money for Jim long-term, in order to keep it safe for him, for a tiny fee, of course, after all my big vault is pretty nice and very safe.  So Jim stores $75k in my vault and wants access to some small amount of it at any time.  Ok, so I tell him I am going to use some of that money to help you out, so I give you a loan for $150k and keep $25k for Jim when he wants it.  Everyone is happy.  Until you lose your job.  Now you can’t pay me.  I can’t operate without rent and payroll, so I have to do something.  I could use Jim’s money, but he won’t be very happy about that, so I have to take the house and try to resell it.  So what is my net worth now?  Harder, but I have a $150k house and $25k of Jim’s cash, but I owe Jim $75k, so I am right around $100k again, right?  Suddenly Jim loses his job too, but it’s Ok, cause he has $75k saved up in my safe vault.  So he comes by and would like to have it back, please.  Of course, Jim, but I only have $25k right now.  Now what?  Jim needs his money but I don’t have it.  Jim blames me.  He says I should never have lent you the money, but the Fed said I really should or else.  So I have to liquidate whatever assets I have to pay Jim, which is only fair.  Now what’s my net worth?  And what if I can’t raise Jim’s money?  I will be ruined!

That’s the situation the U.S. financial industry was in by 2008.  Multiplied by millions in size and complexity.  By the way, I am not saying the banks were blameless.  ARM loans are just plain wrong.  I don’t normally mind preying on the stupid, but there must have been some shady deception going on with some of those.  In the super simple example above, my net work is still actually $100k, even though it’s all tied up in a bad investment.  The bank would sell the house eventually, and probably take a loss.  The hope is that the loss is less than the amount paid into the mortgage before the default.  And the 3rd party would get their money as promised.  The problem comes when the 3rd parties cannot wait for the physical assets to be liquidated and start to panic.  The Fed recognized this in 2008 and did something about it.  They made funds available to the banks in order to be liquid and not cause a panic.  The actually learned from the 1929 Crash.  BUT, and this is where I blame the news agencies, these were NOT gifts.  They were short-term loans with interest, albeit very large.  I need to look it up, but I believe they have all been paid back to the Fed (Us, the taxpayers), with interest.

So in the end, the banks took a loss but were not destroyed.  The housing industry eventually settled for the most part.  No panic ensued, although I suspect some people were disappointed by that (*cough* CNN *cough*).  And the Fed actually made a profit.  Unfortunately, a lot of people were hurt by buying houses they shouldn’t have and ruining their credit when they defaulted, and many more ended up with houses they will probably never profit from.    Many bank executives lost their jobs over this too, which no body is upset about, I imagine.  And, I don’t think the Clintons were hurt too bad.  It’s not like they’d try to run for public office again or anything….  *sigh*

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Filed Under: Life | Politics | Rant

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