Is the Sky Really Falling?

It was interesting to hear further elaboration by a couple of the 200 economists who signed a petition against Treasury Secretary Paulson’s original proposal.

I have heard complaints that when Bear Stearns, Washington Mutual and Wachovia failed, JP Morgan Chase and Citigroup bought their good assets at pennies on the dollar, while the government guaranteed their depositors and took over their bad loans.

I’m not complaining about that. The government seized these liabilities in the orderly liquidation of the failed banks. It did not buy the liabilities at inflated prices, to cover the banks’ rear ends—as Paulson seems to have proposed. Furthermore, the FDIC has a pool of insurance dollars from a long history of collecting premiums from those banks. It does not need to borrow hundreds of billions of dollars from foreign countries or from future tax payers to guarantee depositors.

What happened was simply the proper functioning of the FDIC and the US bankruptcy system. These institutions were established long ago to handle financial crises like the current one, and their personnel are experienced in such matters. These institutions already cost US tax payers some money, but not an additional $700 billion concentrated in the hands of a single individual.

I know that banks continuously assign values to other banks. That’s why they can act quickly when there is an opportunity to acquire one at bargain prices. It is possible that neither the FDIC nor the US bankruptcy system are so well prepared. However, it would cost a small fraction of the $700 billion for the government shore up these institutions to handle the current crisis quickly and efficiently. They could even hire people from the failed banks!

Tags: Economics, Politics

Updated at: 2 October 2008 12:10 AM