Tuesday, September 30, 2008

Should We Bail Out on Bailing Out the Banks? Not if we don’t want to all go down with them in another Great Depression. The Bail-out Bill offers them a loan they have to repay gradually – with interest – and protection for ordinary Americans

Yes It’s An Unfair Situation

It’s completely true that de-regulation by governments (and possibly to some extent the wrong kind of regulation) caused this crisis. It’s true that bankers and mortgage brokers acted irresponsibly too in taking commissions and bonuses for short term gains from loans and mortgages which they knew were unlikely ever to be paid off.

It’s true that the effects are unfair on people who weren’t responsible for those decisions and that ordinary people were being asked by the Bush administration to pay from their taxes (or from their money being devalued by printing more money)
for the irresponsibility of the government and some very wealthy people.

The banks and the stock market traders have been utterly irresponsible , have lobbied governments to de-regulate – and governments – Republican and Democrat, Conservative and Labour, have irresponsibly agreed for the last 28 years. When the banks fail they believe they can blackmail taxpayers into bailing them out to prevent them dragging the whole economy down with them. This has happened many times around the world with Hedge Funds and other financial institutions. So ordinary people on both sides of the Atlantic have been understandably angry at their taxes being used to bail out the wealthiest people in the country, on the basis that it isn’t fair – and they’re right it’s not. Opponents of the bail-out also point out that if their own small business went under the government wouldn’t bail it out. So why should their taxes help bail out big banks or the results of governments’ decisions they ask?

If the banks go down we all go down with them though

The bail-outs have to go ahead though because otherwise panic will continue to spread and more banks will collapse and more people will lose some or all of their life savings or their jobs or their houses. The Great Crash of 1929 started with a rumour about one bank. People began to panic and soon everyone with money in that bank withdrew it all at once. Every bank gives loans and mortgages which total more than the amount of money deposited by their customers. This doesn’t really have any harmful effects as long as most of the banks customers don’t come and demand to withdraw all their money at once (which they almost never do). This may sound worrying as there’s a certain amount of ‘imaginary’ money involved. However this is usually loaned out to people who have just bought a new house and will eventually pay off the mortgage plus interest, or who are setting up a new business or developing a new technology which will create lots of new jobs in the long term (and also repay the loan they took out plus interest). So the ‘imaginary’ money actually allows the ‘real’ economy to grow faster (and when it comes right down to it all money and the value of everything is a matter of how much people will pay for it at that moment).

It’s true that many mortgages and loans were made to people who couldn’t afford to repay them. While many of them have been asked to take ‘their share of the blame’ it’s unlikely that they would have taken on debts they could never repay or ‘variable rate mortgages’ (i.e low interest rate at the start, then it rockets up after a couple of years – or according to variation in base interest rates) if the people selling them to them had told them the full facts and all their options (e.g to take out a fixed rate mortgage). Since the mortgage brokers often got a commission for each mortgage they got someone to take out the long term consequences weren’t of much interest to some of them. Some also claim that government regulations in the US which required banks and other lending institutions to give a certain percentage of loans and mortgages to people from ethnic minorities (mostly on lower incomes) and low income groups with little collateral (i.e whose houses weren’t worth much). This may have been a factor, though companies in the past have been very good at evading regulations they didn’t like by interpreting them the way they wanted to – so it’s unlikely banks gave out many such loans unless they also wanted to because they valued short term profits over long term consequences.

This isn’t a blank cheque – if it’s passed the banks have to re-pay the money eventually and their debtors and mortgage holders will be protected, plus…

So the Democratic leadership in congress (including Senator Obama) demanded that any deal include proper regulation and oversight of the financial industry to prevent a repeat of the crisis. They also demanded that it include some protection for people with mortgaged houses and the condition that when the banks start making a profit again they’d have to start using some of those profits to re-pay the loan from the government – and pay interest on that loan. They also included conditions limiting pay and bonuses for bank managers, so they couldn’t continue rewarding themselves despite having created an international disaster.

There’s no way they could have justified the initial Bush administration plan – which was that tax-payers give the banks a $700 billion blank cheque, with no new regulation, no conditions, no safe-guards for debtors or mortgage-holders – many of whom would risk bankruptcy or losing their home after their taxes paid to bail-out the banks and building societies.

This was agreed on by the Bush administration and the leaders of both parties in congress. Yet when it came to the vote two-thirds of Republicans and one-third of Democrats voted against the bill.

So why did so many congressmen vote against the bail-out bill?

Some Republicans voted from an extreme ideological ‘free market’ view-point which argues (against all history and the Great Depression) that all problems in the economy are caused by government regulation and so the best thing to do is let the wonderful free market fix itself or ‘make an adjustment’ auto-magically. They see any government regulation of or intervention in the economy as a ‘restriction on freedom’ or even as ‘tyranny’. The trouble with this is that, as the Great Depression and John Maynard Keynes showed, the ‘adjustment’ may be to a new equilibrium by itself, but that may well be one in which many more people are unemployed and the economy is much smaller due to a vicious circle of unemployment reducing the amount of money spent causing more unemployment. Unemployment, extreme poverty and dying young after suffering those and resultant stress, malnutrition and illness are a much worse form of ‘tyranny’ than regulating the economy could ever be.

Senator John McCain even backed a plan by some of the right wing among Republicans in congress which contained no provisions for any of the $700 billion ever to be repaid, no protection for people with mortgages or loans that might get called in after the bail-out and a suspension of capital gains tax for 2 years – basically another tax cut that would mostly benefit only the very wealthy. This also almost sabotaged the deal that had already been agreed. Then McCain pretended he had tried to ensure ordinary taxpayers were protected.

Some Democrats probably similarly had an ideological view that it’s unfair for ordinary people to have to bail out the wealthiest. While I’ve sympathy for that view-point the trouble is that if there isn’t a bail-out then almost everyone will suffer from the likely economic collapse – from the richest to the poorest. In 1929 when the Great Crash in the stock market took place many people were unconcerned and thought the bankers had got what they deserved – only later realising they had lost most or all of their own savings as a result.

However I suspect most people in congress who voted against the bill had neither of the above as their main reason. They’ve been getting mail and phone calls and emails from their constituents – and most are asking them not to vote for a bail-out as they see it as unfair that they should have to pay to bail-out banks which, in reversed circumstances, would fore-close on their loan or mortgage. (This doesn't mean the majority of Americans oppose a bail-out - a poll by Zogby polling on 21st September found voters split 46% for and 46% against on whether to back Bush's initial bail-out plan - and that was before all the changes to it negotiated by Obama and the Democrats. So it just means those opposed to any bail-out on any conditions are the ones actively campaigning and lobbying their congress people against it)

I suspect most members of congress know the bail-out has to happen but also know most voters are against it and that there are Presidential and congressional elections coming up. So they gambled that enough of their colleagues would vote for the bail-out for it to go ahead and prevent further damage to the economy and people’s savings and investments, so they could vote against it and get the best of both worlds – economic crisis averted while avoiding voting for the unpopular measure needed to avert it. (This type of behaviour is known as ‘free riding’.)

Some Republican leaders blamed a ‘partisan’ speech before the vote by Democratic Party House Speaker Nancy Pelosi which had blamed the Bush administration. While this may have been a factor I’d have to agree with the Democrat who said it was ‘unbelievably petty’ to decide to punish the whole country because your feelings had been hurt by something someone said (I’d only add it’s likely to punish people in other countries too).

Most Americans who know what the bail-out bill now includes are for it

A poll by Rasmussen polling has found that

"Those who understand that taxpayers will eventually get much of the money back support the bailout by a 2-to-1 margin. Those who incorrectly believe the government will not be getting money back oppose the bailout by a 62% to 18% margin"

The Choice We’re Facing

It’s been shown over and over again through-out history that companies and banks and markets which aren’t regulated by governments collapse and destroy themselves sooner or later – and that the only solution is government intervention and then re-establishing regulation. The suffering caused by economic collapse itself is bad enough – as with the mass unemployment, poverty and hunger of the 1920s and early 1930s. A soar in support for extreme undemocratic political movements – fascism, communism and Nazism – followed (Poverty and suffering caused by civil war in Afghanistan and dictatorship and economic sanctions in Iraq have had similar effects).

Then, when enough people were desperate enough to support any party that would intervene in the economy and give them an income from a job or welfare those extreme parties came to power. Then they started World War Two.

What began in 1929 with the Great Crash of the stock market in the US has come close to happening in the present – but this time we know what we should do to stop this disaster and what will make it worse.

We can still prevent it. Extreme ideologies should not be allowed to blind us to the lessons of the Great Depression – and those manoeuvring for votes in an election year should consider what the result may be if they play chicken with one another for too long. Those congressmen who vote against a deal may gain votes in the short term – but if their actions prevent a bail-out and lead to most of their voters losing their jobs, their houses and their life savings those members of congress can be sure it won’t be long till they’re kicked out of office and replaced by the same voters with someone who will intervene to protect their interests.

Members of congress have also been contacted by massive numbers of voters from their districts asking them to vote against the bail-out. If they continue to get a majority of congress to vote down the bail-out though then they all risk losing their own jobs, investments, pensions and savings the same way people did after the 1929 crash. The Rasmussen poll shows Americans who know what the bail-out bill includes are for it by a 2 to 1 margin. Only among those who wrongly think it's a blank cheque is there a majority against it. So those who're for the conditional bail-out need to contact their congress-people asking them to vote for the bill - and set up their own blogs and websites campaigning for it, so congress people don't get the false impression that most people oppose it just because its opponents are the most vocal.

The bill includes full eventual repayment of the $700 bn – plus interest; it protects people in debt or with mortgages; it regulates the banks so this can’t happen again; it limits bank managers’ pay and bonuses so they aren’t rewarded for this. It’s the smart thing to do. It doesn’t let the big money institutions blackmail us into giving them a blank cheque, but it means we don’t all go down with them either.

Voters in the US could even demand that when some of the banks start making a profit again and the government starts taking a share of those profits in repayment that it then return that money to every US citizen in equal payments, much like the one-off, token 'economic stimulus' payments to every American made by the Bush administration, but continuing until the $700 billion plus interest is re-paid.


nemov said...

I'll have to disagree with your assessment on the Great Depression. Most people didn't have money invested in Wall Street so the crash didn't effect most Americans. However when Hoover raised taxes to print money (gold standard), raised tariffs, and raised interest rates it turned a recession into a depression.

FDR didn't really change the policies. The tariffs gradually went down but FDR intimidated Wall Street in an investment freeze that lasted until World War 2. If you look at the economy during the 30s FDR's policies didn't help do anything except prolong the depression.

FDR's leadership though helped the country from falling apart.

calgacus said...

You might well be right there Nemov. Galbraith mentions the gold standard and other government restrictions of the money supply (done on the advice of economists) as causes of the depression.

However the crisis has led to no-one being willing to provide credit or loans, which is very bad for the economy and for any businesses which would be viable in the long term but need a short term loan to get them through a tough period. That's got to have a similar effect to restricting the money supply surely?

If the bail-out went ahead the government in the US would become a lender and to make all the rest less afraid to start lending money to one another again.

The policies of FDR you mention certainly sound harmful but other policies in the New Deal - e.g government works programmes - weren't.