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
Basically, the money you and I have is only good as long as you and I both think it is. Money is in a lot of ways a confidence game. But usually this doesn’t bother us because “the banks” are around as a kind of creaky grown up who’s supervising the rest of us who are kind of just playing store with our money.
What happened in 2008 was that the banks honestly fucked around hard. And when they first started finding out it was really scary because it happened really fast. The first bank that went down I don’t think was actually a bank. But it was called Bear Sterns and went down in like twelve or eighteen hours. Bear Sterns was publicly traded. So a lot of rich people lost money but also a lot of regular people like you and me.
When this happened the government panicked. They made J.p. Morgan buy Bear Sterns so that they could get some of the money back for people. But two things became more apparent when the next financial institution (Lehman Brothers) went down three or four months later.
1 – when banks/financial institutions go down, it’s not just the depositors who lose money. Banking is too connected now. So Lehman Brothers going bankrupt was now affecting a bunch of different people whose money was now locked up because they’d been doing business with Lehman or they had accounts there and they couldn’t get it at a time when they really needed it.
2- when Lehman brothers went down everyone learned the wrong lesson. They didn’t learn “this company fucked around and found out” which was the lesson the government was clearly trying to teach. They learned “Lehman went under and every person who stayed to the end is fucked now”. Which is basically how you get a run on everyone all at once, because now your money isn’t safe anywhere. So banks that were actually fine (they’d lost money but nothing really problematic) started being in danger because they were there and they had peoples money and people were scared to wait too long to get it and then not be able to. Things were getting a bit shaky.
The AIG blew up. AIG was stupid. They didn’t mean to be but they were. They made bad bets and they made a lot of them and they didn’t think this was a problem because they had a lot of assets. Which is totally true. But AIG was cash poor. Insurance is very regulated (likely due to the long tradition of insurers screwing people) so alot of their assets weren’t things they could sell. The bets they made were like a bad insurance policy and all of a sudden everyone was trying to cash in at once. They owed a lot of people a lot of money. And AIG was more connected than a lot of the really big financial institutions. They were in a lot of places and if they suddenly disappeared then everyone was going to get screwed instead of just the people who were unlucky enough to be connected somehow to Lehman Brothers.
What the government (Hank Paulson and Ben Bernanke to be specific) were worried about wasn’t that a few places were going to go out of business. They were worried that money was going to stop working. For everyone. In regular everyday life things. And then people were going to get scared and they were going to get mean. And Paulson and Bernanke thought they could fix it with like an obscene amount of money to AIG so they did. They loaned AIG the money and then they made the banks all take some too so people would see that the banks were ok because the government said so. The government gave them money and the government promised they were ok. They were hoping people would buy that because it’s how we’ve always understood the system to work. And enough of us did. And they did manage to stop the bank run.
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