A Response to Comments on my Last Bailout Post

Some of my favorite people, Justin, B-daddy and the Ohioan, stopped by and left comments on my (allegedly) last post on the bailout. My response got pretty long and I've decided to make it a post in and of itself. I'm just excerpting from the comments left there, you can wander over and see their full statements for yourself.

Here we go.

B-daddy

Absent guarantees that government will repeal the Community Re-investment Act, dismantle Freddie and Fannie, and have a time certain limit on unbundling the bad assets, I cannot support this bail out. And the fact is, once one starts down such a path, such guarantees are almost always broken by government anyway.

The Ohioan

I don't like big government, I don't like the nanny state, and I really don't like the government getting involved with private markets.

Since you sort of asked us to choose, I guess in this case I think the first is worse than than the second, so with very lukewarm support, I'm in favor of a bailout.

My reply

Thanks for the comments. (I luvs comments! I must has moar!)

:-)

I stopped by my local Wells Fargo branch yesterday to talk with the investment banker there. We chatted about the WaMu takeover. He said their Wells Fargo branch had seen lots of people walking in with money pulled out of WaMu opening accounts at Wells Fargo. It was the beginning of a run on WaMu.

I think the terror of the situation is not in the economics, but in the psychology. You just can't afford to have runs on banks. Once it begins, no one will know who is solvent and who isn't. Rumors will spread and people will leave work to get their money and if nothing else, just keep it in cash.

No bank has the reserves to withstand that kind of panic. Even the healthy ones like Wells Fargo and JP Morgan would go under. That's why this bailout is necessary. The posts and comments across the blogosphere all focus on the rational response to what's happening. In truth, we probably could swallow a few toads in the form of bank failures and survive if it didn't result in a panic. However, man is not a rational animal, he is a rationalizing animal.

The bubble was created in part by mortgage brokers deciding to make money for themselves by making lousy loans, knowing they were contributing to the upcoming crash, but also knowing their contributions were so tiny that if they stopped, the only effect would be less money for them personally. In the same way, each individual would rationalize pulling their money out of their bank by deciding that their deposit was so small that it would have no effect on the bank run, but if they left it in they could suffer major losses personally.

Finally, B-daddy's fear is well founded. The dispensation of bailout checks will be managed by a Democratic congress and quite possibly an Obama administration. We got into this mess because they have yet to accept the notion that poverty has very little to do with money. Through the Community Reinvestment Act, first a Carter and then a Clinton program, they made sure that loans were available to people regardless of credit history. The redistribution of wealth will be at the heart of the bailout execution. You can see it in their press releases. Both Chris Dodd and Barack Obama think that mortgage defaults, caused by a non-existent recession, was the cause of this crash.

In spite of that, I would rather have $700B in the hands of Barney Frank and Nancy Pelosi to hand out to homeowners who couldn't balance their checkbooks if you held a gun to their heads rather than a panic and a run on the banks.