What would have happened with no bailout?

Economics Economics Questions
1

I was having a discussion over the weekend about what would have happened if there had been no financial bailout (Emergency Economic Stabilization Act of 2008). We are told that without the bailout we would have suffered “an economic meltdown”.

It seems even those who support a free market grudgingly accepted that the bailout was necessary. They say things like payrolls would not have been met because lines of credit would have been cancelled. It’s hard to argue for non-intervention when the claimed alternative is mass unemployment, food riots, and martial law.

Personally, I think liquidation of the insolvent firms would have led to the quickest recovery, but I have difficulty defending this position against predictions of total economic collapse.

Does anyone think that the economy could have survived without the bailout? What would have happened had no intervention occurred?

2

Here is what not to do. Essentially doing the opposite is the correct cause of action.

GOVERNMENT DEPRESSION POLICY: LAISSEZ-FAIRE

"If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don’t interfere with the market’s adjustment process. The more the government intervenes to delay the market’s adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite “anti-depression” arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:

(1) Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.

(2) Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government “easy money” policy prevents the market’s return to the necessary higher interest rates.

(3) Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.

(4) Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.

(5) Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of savedcapital even further. Government can encourage consumption by “food stamp plans” and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed.15 Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.

(6) Subsidize unemployment. Any subsidization of unemployment (via unemployment “insurance,” relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available." - America’s Great Depression, p19

3

!(http://www.zerohedge.com/sites/default/files/images/user5/imageroot/trichet/Dallas Fed.jpg)

4

check out this thread. I wouldn’t call it ‘definitive’, but there’s some good stuff in there.

5

“Does anyone think that the economy could have survived without the bailout?”

What does “survived” mean? Thinking that we would have returned back to the stone age is foolish. We would still have the same amount of capital (“tools and machines”) and labor. It is just that capital and labor need to reallocate as quickly as possible according to consumer preferences. Giving the artificial support to failing banks only prolongs the problems. You are basically taking away from productive producers and giving it to unproductive ones. On the contrary, you are supposed to keep the capital with the productive producers since they can use it to grow wealth by satisfying consumers. What makes it even worse is that most of the bailed banks were large institutions that used a lot of labor and capital. These institutions should be considered to big to bail since they are wasting so much labor and capital for unproductive services. Surely, we should have allowed them to go bankrupt so that their labor and capital would go to productive entrepreneurs. By bailing them we have retarded and prevented a robust recovery.

Another problem with bailing banks is that we have avoided a speedy liquidation of many bad assets (loans) on banks’ books. Basically, this would have involved shaky homeowners default on their payments, which would result in banks repossessing the houses and selling them at fire sale prices to raise cash to pay back the depositors. This way people who have genuinely saved could buy houses at lower prices and remove the glut from the housing market, so that the market can continue growing again. Yes the depositors would have lost some of the money they deposited but then again the prices would fall also due to genuine deflation so their dollars could purchase more. Furthermore, since they would realize that their savings have diminished, they would quickly go back to saving, which would allow for a faster accumulation of capital and resulting investment.

On the contrary, we have keep the shaky banks alive, so now 2 years after crises, we still have banks holding bad assets and not loaning money to productive businesses. They are not fulfilling their role of allocating nation’s savings to productive investment. This has retarded the recovery to an amazing extent. What’s even worse is that they are sitting on these huge inventories of houses thus preventing adjustment in housing market as well. What’s ironic is that these banks have turned from their loaning services to providing “subsidized housing”. Instead of loaning money to productive businesses, they are basically letting borrowers who have defaulted on their payment live rent free in the houses.

So to answer your question----no we would have survived and actually we have would ended up having a much more robust recovery

6

I’m no banker, or banking expert. But I’d like to expand a tad on slobodan fon miroslavljevic’s excellent point----namely, that we would still have the same amount of capital (“tools and machines”) and labor.

I wish I knew more about banking, so I could understand this stuff better. Anyhow…

re: the bank’s clients (i.e. I don’t know who exactly are the bank’s clients, nor what the bank’s business model comes down to when the rubber hits the road, but…) re: the bank’s clients who have been extended lines of credit with the bank:

Seems to me the problem caused for these folks is that their line of credit immediately dries up, so they’re left with partially-completed capital projects. This may cause many of these folks a lot of trouble. However, as slobodan fon miroslavljevic points out, the capital project—however incmoplete—doesn’t just evaporate from the face of the earth. In whatever stage the project stands when the credit line is yanked away, that project still has value (perhaps great, perhaps small).

The market should decide, at this point, which projects to continue funding. If the projects are deemed valuable, other banks will pick up the slack and extend new credit lines. The invaluable projects will be scrapped, or whatever. But, this is the point of why the bank should be allowed to fail: If it funds a bunch of crappy projects, it is being run by decision makers/entrepreneurs who don’t belong in the business because they make a lot of bad decisions with society’s hard-earned savings (yea, I’m assuming away the FED and printing press dollars here.)

At least, this is what occurs to me. I could be wrong about it, because I’m no kind of banker. Seems right to me though. Hope this is helpful.

7

bcyclwutztht,

That’s a good point. We have kept in business banks and decision makers who have proved incapable of allocating funds to profitable projects.

I made a fallacy when I said “yes depositors would have lost some of the money they deposited” if the banks weren’t bailed out. With or without the bail out the depositors have lost their money. By bailing out the shaky banks, the Fed has papered over the loses, but they are still there and are being realized in a different way. The Fed has basically increased the amount of money in the system thus reducing the purchasing power of depositors. This way it has socialized losses in a hidden way. Most of the public is completely oblivious to this. The bail out has created an even bigger problem since it has rewarded depositors who haven’t monitored their banks at the expense of the depositors who have kept their money with good banks. Furthermore, this increases the moral hazard among individual depositors since the depositors don’t have an incentive to monitor their banks knowing that the FDIC/FED is going to bail them out. Lastly, as bcyclwutztht pointed out, the bail out has kept in the marketplace institutions and decision makers who have proved inept at loaning money for capital projects. With those decision makers entranched in the places of power and future promises of bail out, these bailed instiutions will probably end up making more bad loans than a healthy banking system would having gone through a real recession. And more bad loans translate into greater destruction of savings depositors deposited with the banks.

8

This may be a cop-out but the stimulus was/is childs-play in comparison to what the fed was doing at the same time.

ExampleA

ExampleB

ExampleC

There is more out there, for a while there the Fed was breaking it’s own records on a weekly basis for volume in weekly lending during 2009.

So without the stimulus it’s likely that the geography of our market may be a bit different, but the overall health of it would still had been very poor. Rampent mal-investment all over the place.