Bailout Plan Is Like Pushing on a String

Published September 22, 2008

To summarize the present financial crisis:

1. A lot of mortgages at variable interest rates were given to borrowers who were not qualified

2. The housing bubble was created by the Federal Reserve who held down interest rates below the natural level.

3. Home owners with existing mortgages were encouraged to borrow on a tax-deductible bases to purchase consumer durables like autos, washers, dryers, and dishwashers.

4. Mortgages were consolidated into securities and the financial institutions took out insurance in the form of credit default swaps.

5. Real estate defaults began to rise which caused investment banks to restate their balance sheets.

6. Share prices of banks decline and for some institutions, total collapse occurred.

7. The market in credit default swaps also collapsed.

8. The Treasury proposes a $700 billion bailout of the banking industry, Bear Stearns, AIG, Freddie Mac, Fannie Mae and others to be named later.

9. The Securities and Exchange Commission has banned short selling on bank stocks, even though a previous ban on the shares of 19 banks proved counterproductive.

10. Congress, mainly Democrats, want to bailout the unqualified borrowers who were accessories to the original crime.

Will the bailout work? The one-word answer is NO.

The more complete answer is that banks, once burned, will be twice shy in making new loans. A lot of lending will not take place. That, in turn will cripple the economy.

The bailout will surely exceed $1 trillion and attach a permanent string on the money in the taxpayers pocketbooks, on which the government will frequently pull. 

Forcing banks to make loans is unacceptable even in the present political circumstance. Just allowing banks to make any but the most secure loans will not work either. This is like pushing on a string.

Jim Johnston ([email protected]) is a policy advisor to The Heartland Institute. The views are his own and not necessarily those of The Heartland Institute.