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Con: Bailing out the blunderers won’t fix anything

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Mark Weisbrot
October 11, 2008
EDITOR’S NOTE The writer is addressing the question, Is the financial recovery bill the right answer for America’s economy?

It is now clear the approval by Congress of President Bush’s $700 bailout package has done nothing to ease the current financial crisis. Credit markets have worsened for several days after the bill passed Congress. The stock market also plummeted to nearly 10-year lows.


So much for dire warnings from the Bush administration that Congress was risking a Great Depression if it did not quickly fork over the dough. The bailout’s supporters said Congress had to do something to unfreeze the credit markets. It didn’t work.


There is a basic misunderstanding of the current financial crisis and economic recession that is widespread. Most people think the current economic downturn—which will be officially designated a recession sometime in the near future—is the result of the financial crisis. But this is not true.


The current recession is mainly the result of a collapsing housing bubble. This bubble of more than $8 trillion accumulated between 1996 and 2006, and it is only about 60 percent deflated so far. This means that even if all the problems in the financial system were miraculously solved tomorrow, the United States would still be facing a serious recession.


Of course the financial crisis can make this worse, as financial institutions cut back on lending and short-term interest rates for commercial borrowing rise. And we are indeed facing a serious financial crisis. But the bailout package is a wasteful and inefficient way of dealing with the problem of banks holding bad debt, mostly related to mortgages gone sour in the housing bust. It enables the U.S. Treasury Department to buy up “troubled assets”—mostly mortgage-related securities—from financial institutions at prices that will likely be much higher than they are worth.


Economists across the political spectrum saw this as a wasteful and inefficient way to fill holes in banks’ balance sheets. Ordinary citizens and taxpayers saw the bailout as an enormous rip-off and flooded Congress with phone calls, defeating the bailout on its first vote.


Indeed, the most important ways that our government is holding the financial crisis in check do not involve overpaying banks for bad assets.


The Federal Reserve and U.S. Treasury have intervened repeatedly to pour liquidity into the banking system. They have agreed to federally insure $3.4 trillion of money-market mutual funds held by millions of Americans. This week the Fed created a new facility to buy commercial paper, the short-term debt issued by banks and corporations, where lending has been shrinking. The federal takeover of Fannie Mae and Freddie Mac, and the nation’s largest insurer, were also necessary to preserve the stability of the financial system.


All this is just the beginning of cleaning up the mess that has resulted from a deregulated and unregulated financial system gone wild.


The government will have to take over more insolvent financial institutions and provide capital to others. It will have to take steps to help homeowners, to minimize foreclosures and evictions. And it will need to provide the largest fiscal stimulus package since the Great Depression to prevent this recession from dragging on for years.


The worst part about the bailout is that some politicians will say we can’t afford the necessary stimulus because we just added $700 billion to the national debt.


Americans will have to fight for measures that protect the public interest, not the interests of those who made this mess. Treasury Secretary Henry Paulson made $163 million as CEO of Goldman Sachs in 2006. Now he and his former colleagues at Goldman are running the Wall Street bailout.


During the Asian financial crisis 10 years ago, there was an expression for this kind of system: “crony capitalism.”


Mark Weisbrot is co-director of the Center for Economic and Policy Research. Readers may write to him at CEPR, 1611 Connecticut Ave. NW, Suite 400, Washington, D.C. 20009-1052; Web site: www.cepr.net.

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