mathgeek

Why It's Better to Bail Out Borrowers than Banks

Felix, while I prefer to keep the details private, I was living fairly close to the fire in this chain of events... and it was all about psychology. Everyone, from market participants to the media was playing the game of "whose next?"

While Leman was alive, the focus was there. The moment Leman fell, the focus shifted to WaMu and Wachovia... and please remember... WaMu was wiped out in less than two weeks not by losses... but by panic deposit withdrawls. As soon as WaMu went under, the pressure shifted almost instantly to Wachovia and Morgan Stanley.

What the regulators realized they needed to do was to draw a line underneath the financial system and say, this far, and no further. That is why TARP funds were crammed down all of the largest banks... the government needed to make it clear that the government would not allow either speculative attacks nor a deposit runs to close any more major institutions.... Period.

And, for better or worse, it worked. Almost overnight, speculation about who would be the next to go ended and that phase of the crisis ended. Now, its not at all clear that WaMu or Lehman share or bondholders were treated fairly... why let them hang while protecting Citigroup, for example? But the decisions were not made on principle, they were made in response to a chain of events, and by the time WaMu and Wachovia were gone, the Fed realized that they had to stop what had basically become a rolling bank run, and consistancy of policy was far less important than changing the psychology... and at the point, the train had already left the station on bailing out borrowers. The Fed needed to credibly back the remaining financial institutions, and they did.