An Alternative to the Bailout 14 comments
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I have searched the depths of the internet for a legitimate article with the above title; I have come up completely empty-handed. This being the case, I would like to offer a bold and simple plan - instead of a bailout, we can offer a stimulus package.
The Alternative
We all (well, not all, but most of us) received an "economic stimulus" check from the government a couple of months ago at a cost of about $150 billion. The objective of these funds was to stimulate the economy. Their effect was largely negligible by most economists' accounts. It seems that $150 billion just does not do all that much in a $13 trillion economy (just over 1%).
What would happen if instead of $150 billion, we gave out $1.5 trillion? If we wrote out a check for $5,000 to every man woman and child in the United States, there would be significant movement in the economy. The benefit would be largely universal, and would affect every aspect of the economy. So while losing the focused target of the bailout, we would be able to achieve the desired effect - albeit for considerably more money - without all of the negatives listed above. The financial institutions would gain substantially - as can be seen from the reaction of the stock market in the week following the announcement of the original stimulus package (January 23rd - February 1st) when Citigroup (C), Bank of America (BAC), and JPMorgan Chase (JPM) each gained over 20% in market value, Washington Mutual (WM) gained over 60%, and even Goldman Sachs (GS) and Merrill Lynch (MER) gained 12% each.
Why was there such a jump in those financials back then? Because the general market understood that if there is another $150 billion in the average consumer's pockets, they will need to transact with it... ergo financial profits. The most direct way to increase financial "sales" is to manufacture more cash.
Detailed Effects
What would happen? A substantial cash infusion based on head-count (per person, not based on income or assets) would allow a virtual do-over to those that made bad decision in the past. Those that are that are on the brink of foreclosure will put their money toward saving their homes. Those that have substantial credit card debt will pay it off. Those that have lots of money anyway will put the money in the bank, or spend it. How do these funds work their way through the economy?
The undesirable "toxic" assets that are to be purchased in the bailout would see an immediate increase in value and liquidity due to the substantial increase in funds available to subprime borrowers, and the increased likelihood of repayment. The financial institutions will also see a substantial increase to their capital bases, allowing them to weather the current liquidity crisis better.
These same financial institutions will also have a sudden increase in value due to the increase in their future potential earnings because of the substantial increase in cash available in the market and their vaults. The increased value of these financial institutions, coupled with the increased fundamental value of their mortgage backed assets (due to the lesser likelihood of foreclosures), and the increased general liquidity of funds available for the purchase and sale of all kinds of assets (does anyone remember when the term of art on wall street was "awash with capital"?), should be able to stave off the mass disaster that we are all fearing.
The increased capital will also spur growth at many of the other consumer based economic positions. A job spur would also likely be in the coming. A general economic boom could be the effect of this sort of stimulus package.
How much affect would $1.5 trillion have? Consider scale - the current M1 money supply (all the cash in the country plus all the money in our combined checking accounts) is just under $1.4 trillion. Doubling the money supply over night is huge...
Inflation
When there is a substantial influx of cash into the market, we run the risk of inflation. Inflation is a complex animal, but the two basic forms of inflation are the dilution of fund value (printing currency) and the over-supply of capital for under-supplied goods and services (over heated economy). A stimulus package today should not substantially adversely affect either of these inflation drivers. Due to the economic contraction of the past year, the economy has plenty of room to grow before reaching its limits. Unemployment, while not staggering, is substantially higher than it was two years ago, proving that if the demand were there we have the labor to provide for it. And dilution of currency should only affect inflation if the currency is printed, which in the case of a stimulus package it would not be... it would be borrowed.
The greater risk is that the dollar would be adversely affected, and that if there is limited demand for treasuries, interest rates would rise. The fact is that treasuries remain the safest haven for risk aversion, as is evident from the extraordinarily low interest rates currently - despite the fact that the whole world expects the issuance of another $700 billion in treasuries, 5 year treasury yields are exactly where they were in the beginning of the month. So interest rates will not necessarily move substantially in this environment.
The dollar may be devalued against other currencies, but in the current environment, that is not necessarily a bad thing for the short term, as it would spur exports and tapered imports. The inflationary affects of our imports would likely also be tapered due to the ties between the huge foreign treasury holdings in competing countries.
Ultimately, there may be some minor negatives with relation to long-term debt levels, but fiscal responsibility should be able to bring these issues under control with time. Ultimately, the basis for this idea is that we have a momentary lapse of fiscal liquidity today, and we are using Government to borrow from our fiscal liquidity in the future.
The Current Plan
My aversion to the "bailout" is multi-fold. I believe it creates a terrible precedent. I believe it should not be the job of government to involve itself in the workings of business. I think it would be a terrible idea to create a sovereign wealth fund which would be managed with extremely little oversight. I believe it would be an even worse idea to create a sovereign wealth fund which would be overseen by congress. I see no reason why, if held properly, these assets would not offer a very positive return to the government. I see no chance whatsoever of the government actually making money off of this bailout. I think the currently generally accepted concept that privatization and lack of regulations were to blame for the current crisis, and that the solution should include substantial new regulation and public ownership will result in the single greatest set back to financial progress in recent history.
Every one of these issues are avoided with a stimulus package. Moral hazard would remain, since the worst of the worst will likely still fail. There would be an overall boost to the economy at a time that one would be useful. Congress would not get to decide on what to spend a trillion dollars on. We would.
Political Realities
The Democrats in Washington would love this idea. They have not brought it up because they either have not thought of it, or are afraid of being labled "spenders". The Republicans hate the idea of the bailout. It goes against everything they stand for in small government. They just have not seen an alternative that would work. Bear in mind, writing a $5,000 check to every American is not "spending" money. It is most similar to cutting taxes.
This can only be done if there is support for it NOW. The reality is that the bailout is becoming more and more relied upon every day.
The Number One Reason
Why do it? Because I would rather give two dollars to America than one dollar to individual banks.
Disclosure: none
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"And dilution of currency should only affect inflation if the currency is printed, which in the case of a stimulus package it would not be... it would be borrowed. "
So we will just "borrow" the money from China / Saudi Arabia / Russia and it won't count as currency dillution because we will be producing treasuries out of thin air instead of greenbacks! Brilliant! Come to think of it, if they're willing to buy an unlimited number of treasuries, why should we pay taxes? We could just live off their generosity forever! I'm glad we find ourselves in such a fortunate position.
Ultimately, I dislike the idea of ballooning our deficit as much as the next guy, but I like to look at the grand scheme a little. Consider the following simplification:
In a country of 10 people, each citizen has a credit card with debt of $100 at an interest rate of 10%. This country institutes an economic stimulus package in which it leverages its stellar credit rating to borrow $1,000 from the Chinese at an interest rate of 5%, and redistributes the funds to every one of its citizens to repay their collective credit cards. In such a simplified scenario, it is easily understood that the citizens and country as a whole would be better off - especially if the country institutes a special tax to recover the expense at the lower interest rate.
In reality, however, life is significantly more complicated... you see, those ten people don't all owe $100 each, but rather1 guy owes $300, 3 people owe $200, 1 guy owes $100, and 5 people are debt free. to complicate the matter, by increasing the liquidity in the market, this country encourages greater risk and leverage as the 5 guys without debt try to lend their money to the three guys who are already in hock up to their eyeballs...
But the premise stands, debt is not a bad thing, so long as it is burdened equally - ironically, it is very similar to mortgage bundling mess that we started with - individually our credit ratings are collectively crap, but together we command significantly cheaper money.
I am not advocating the continued increase in debt to untenable levels. I advocated this Plan largely because in the current state of financial markets there seem to be significant appetite for these treasuries.
Bear in mind, the ultimate cost of Government is not taxes but rather expenditure. Government - with its stellar credit rating - has the ability to balance out market swings by lessening the tax burden in slower economic times (or providing a stimulus package), and raising it in times when there is greater liquidity in the market. Ultimately all expenses end up balancing out.
Government debt and expenses should never be looked at as a singular number. Debt should always be seen as a percentage of GDP. The fact is that Government expenses have been fairly consistent for a very long time. Annual expenditure as a percentage of GDP has hovered around 20% +/- for the last 60 years (WWII is a significant outlier). Comparably speaking, the Bush Administration - with two of the most expensive wars in history, a massive increase in government entitlement programs, the single most expensive natural disaster in US history, the single most expensive non-natural disaster in US history, a quintupling of energy prices, et al. - has (as of now at least) spent on average less per year as a percentage of GDP than the Clinton administration. I still feel the Bush administration royally dropped the ball in allowing Government to grow in such enormous proportions, but the long term trend is clear. We will never pay off our national debt - it is likely not even in our best interests to do so. The best we can hope to do is to "out grow it". If the debt remains constant, but our productivity growth rate increases even marginally, over time our debt will become less significant.
Finally - to all the standard comments we will get about the size of the deficit and how much held by China... The bulk of the united states deficit is ethereal. It is made up of expected expenses like Social Security. To fund Social Security, and similar expenses, the United States hods its own treasury bills as a fake "investment". How much does this add up to? If you only count the potion of debt that is actually held by non-US Government entities, the national debt as treasuries outstanding is hovering around 30% of GDP - The last time it has been that low was during the Carter administration... and you wonder why there is such strong demand for treasuries?
Again, not to say that our economy is humming along smoothly without any significant problems, but oil does seem to fall under the supply and demand fundamentals that the rest of economics is bound by... the more expensive it is the less we use.
The Government will NEVER be as good a judge of resource investment as the private sector. If there were an extra trillion dollars in the economy, the private sector will be best equipped to make a rational decision as to where those funds should be invested.
I hate to give the Gordon Gekko "greed is good" speech, but the fact of the matter is that productivity has been proven to come from those that have a direct interest progress time and time again. Massive regulation is NOT the answer. If you let the people have the money, they will invest it wisely - that is democracy.
When Wall Street absorbs the $700 billion, Main Street banks will pay dearly to maintain their capital ratios.
It makes more sense to distribute the $700 billion to American community banks so they can lend for local transactions or the local banks can use it to recapitalize Wall Street.
The fact is that we have data to prove what Americans would do with their money if they found a sudden windfall - we just had a stimulus package. The main reason that we did not see a substantive boost in economic activity has been attributed to the fact that Americans were using their new found cash to pay off their debts. In the current market environment, it is significantly more likely that the average American will be prudent in covering their financial necessities before moving on to luxuries. But the purpose of a new stimulus package is not so much to stimulate GDP growth, but rather to put the economy on less shaky footing. We are witnessing the substantial deleveraging of the economy, and without a replacement of some of that capital, we will see a financial seizure.
Irrespective of how much money is pumped into the economy in the coming weeks, the era of cheap credit will be gone for many years to come. Foreclosures will still happen, and asset values will still decline. The difference will be that those that deserve better credit, those that have been waiting on the sidelines of the real estate boom hording cash for the market to collapse, those that have been extremely prudent, they will be able to tap the credit markets that are currently closed to everyone.