Instead of bailing out the institutions, why didn’t the government just let them fail and give the money directly to the people hurt by the bank’s mismanagement? Why were the banks’ protected? Doesn’t this kind of protection incentivize banks to act recklessly in the future?
In: Economics
The idea, whether it’s correct or not is not something I’m qualified to comment on, is that the bail out would be much cheaper than dealing with the fallout of the banks failing.
So like they either spent a ton of money to prop up the banks or they banks fail and they have to spend a ton *more* money helping everyone that got screwed over.
That said, when it comes to the bailouts there’s two reasons it’s not supposed to “incentivize the mismanagement of customer funds”
First one is that a number of new laws and regulations came out that made it illegal for banks to do a lot of the crap they did back then. And while banks are definitely out for themselves they do tend to follow the law if the cost of not following it is too high.
Second, was that most of that bailout money was actually a loan. So they had to pay it back.
Leverage. The amount of money people were owed by banks in trouble dwarfed the rescue by two orders of magnitude.
Much more bang for the buck – and more chance of it working smoothly – to keep the institutions alive.
The world financial system was at risk. A global failure of banks would have done damage dwarfing the great recession.
We bailed out the banks because we **had to,** not because they deserved it.
The US didn’t just “give the banks money”. The US loaned the banks the money they needed to stay operational, and made a profit for US taxpayers by doing so
You’re driving out in the middle of the woods. Your cars headlights break, and in the dark you get into an accident. The car can drive (other than the broken headlights) but you might have a concussion. You’re not sure how bad it is, but concussions are dangerous and you should get to the hospital ASAP.
A passerby on a bicycle sees the accident and has the option to help. They could call an ambulance, which might take time. They could give you their bike, but you would be riding with a concussion. Or they could go to the store down the street, fix the headlight, and drive your car to the hospital.
Obviously the best option is to quickly fix the car and use that. It is already the right tool for the job and it’s also the least risky option. Because remember, your goal is to get a doctor help, not blame your mechanic for letting the headlight break. You can worry about making sure it doesn’t break again after you get medical care.
In this analogy, the car is the banks. They were already set up to service people and their banking needs. If you fix the cause of their distress, you fix the immediate problem. Then after there is no more danger you can work on a long term or permanent fix.
Money at the “you” level is important because it represents your ability to purchase goods and services. Money at the bank/national government level doesn’t really work like that.
Money does not make things come into existence. If you walk into a store with $100, $100 worth of stuff does not magically materialize for you to buy. What makes that $100 worth of stuff is people – people who made that stuff months ago in anticipation of you walking into the store with your money to buy it.
What money does at the bank/national government level is to provide a means by which people can exchange labor for things and vice versa.
The 2008 bailout did not involve the government “giving” anyone money. There was a short term disruption to the normal flow of money in the economy that, due to how banking regulations worked, meant that a number of banks were technically operating illegally as they didn’t have enough cash on hand (even though they would have enough cash on hand to function normally once the short term crisis was over).
Closing down those banks would have wiped out trillions of dollars in bank deposits. In that case, the disruption caused by so much money being lost at once would have destroyed people’s ability to exchange labor for things and things for labor. That doesn’t mean that human labor or things would stop existing, but without a means to trade those human civilization would simply stopping working.
Cashing out the bank deposits so that nobody lost any money would have required printing trillions of dollars. Similar money printing was done on a smaller scale during COVID, and most of the economic problems in the world right now are a direct result of that much smaller episode of money printing.
So instead of shutting down the banks and destroying civilization, the government just “loaned” what was basically fake money to the banks so that they were technically operating legally, then waited until the crisis was over and said “the fake money we made up to pretend that the banks weren’t illegally operating a few months ago no longer exists.”
There were some companies that legitimately got “bailed out” – like GM. The problem is that bailed out is an overly simplistic phrase for what happened. What really happened with GM was that the government took ownership of it and subsidized it until the crisis was over. Anyone that was an owner of GM pre-crisis lost the entirety of their ownership in the company and received nothing in return.
At its core, a banking system is a system of trust. ie. If a bank lends money to another bank, there’s a certain level of trust that they’ll be paid back, with some interest (the overnight lending rate).
During the financial crisis, there were rumours that certain banks didn’t have enough cash to operate. As a consequence, banks no longer felt comfortable lending money to other banks. Nobody wanted to be in the situation of losing hundreds of millions of dollars from an overnight loan to a bank that just went bust the next day. So as a result, lending simply dried up, and interbank interest rates went through the roof. All this happened because all these banks didn’t know which other banks were on the verge of bankruptcy (ie. running out of cash). This freezing of credit then spilled over into commerce; regular businesses couldn’t borrow money either to finance their day-to-day operations. This was a big deal. The U.S. economy was on the verge of halting, and then collapsing.
So, the Federal government stepped in and basically forced all the big banks to accept huge loans from the Federal government. This way, everyone could see that all these big banks had plenty of cash and not in any cash crunch. Banks that didn’t need Federal cash were forced to accept, because banks that refused this Federal cash would mean the banks that *did* take the cash were the ones in actual trouble, which would collapse those banks because everyone would know not to lend to them, which would make this whole operation pointless.
This is an extreme over-simplification of what happened, but it should give you an understanding of why the Federal government bailed out the large banks, and why there were few other options, given the time crunch.
The alternative would have been much, much worse.
There’s a documentary called “Too Big To Fail”
In 2008 there was a company called AIG. It’s an insurance company. They sold various insurance, including ones for big corporations.
Too many companies bought insurance from them.
If they went bankrupt, it would’ve screwed over all the companies that relied on their insurance.
It would’ve been a financial global catastrophe.
So the US bought out AIG. And eventually sold it a few years later for $22B.
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So you can call it a bailout, but in the end the US did sell it for a profit. And if the US profits, then the people wins too.
If AIG went bankrupt, all other companies would’ve gone under too. If a lot of companies go under, then the workers would have no job. So at times, it’s better to help companies than individuals – the only problem is that companies know the loopholes to take advantage of the gray areas.
Well keep in mind that banks are levered entities on fractional reserves, so if we let the whole thing collapse it would basically wipe out everyone.
But you make a fair point. The moral hazard is ultimately a bad thing and we should let risk fail and help the most vulnerable in society while encouraging opportunities for newcomers with clean slate.
USA congress were WARN about the equity loan but GOP passed a law preventing the Equity Loan from being cancelled. 25% of white home owners lost their home when 75% of black home owners lost their home.
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