Someone explain something to me about solving the credit/banking crisis please

[harry_pothead]

Instead of doing bank bailouts, why can't the government spend the trillions of dollars on providing direct credit for employers and manufacturers for a couple years? Then let the toxic banks fail, reinstate Glass-Steagall, and then sell the loans to solvent responsible banks.

It seems so simple.

[Qutzupalotl]

1. Send it in!

They're listening...

http://www.whitehouse.gov/StrongMiddleClass/
http://www.whitehouse.gov/contact/

[Aloha Spirit]

2. Hmmm I guess what I would say is, that would take a LOT of credit to to that, and that

Treasury is trying to be a catalyst to change the trends more than a central bank.
I guess the way I think about it is, they're trying to minimize the upheaval.
Just a couple points.

[uponit7771]

3. They are, operating capital is being provided by the government or backed by the government directly

...for commercial paper mostly because of the LIBOR rate isn't down enough for the free flow that we had in 07.

"..Then let the toxic banks fail, reinstate Glass-Steagall, and then sell the loans to solvent responsible banks..."

Because the "real" toxic banks (Shiti-bank, BoA) handle around 30 - 40% of the retail M2 or retail lending to Joe Jane consumer and that is a good portion of our GDP.

If you shut those banks down you kill the GDP for months and that's like taking the blood out of a persons body...waiting then putting the blood back in....you can put new blood in but the person will be dead by then or in our case VERY VERY sick.

On the other hand Krugman et al are arguing do just that right now while no one is spending (US savings rate has gone up around 600%) and the impact will be low....both sides have good ideas.

Obama's allow for less government impact

P.S. Yes, the Bush admin fucked us THAT much when it comes to the banking sector...put it this way...the let the futures regulator go to......................United Kingdom....yes....overseas...

[Kaleko]

4. Thank you for this explanation.

I'm trying to see as many perspectives as possible here. There are indeed good points to be made by either side of the Geithner/Summers/Obama and Krugman/Stiglitz/Soros divide.

I doubt that anyone exists who can see the exact consequences of whatever course of action is taken in every detail. The global economy is simply too big an animal for even so-called Money Masters to control. A very humbling experience all around. Which is good! We need to learn co-operation.

[CTLawGuy]

5. government officials aren't as good at making good loans

as banks are.

Now I know that sounds silly considering the position we are in, but the banks aren't in trouble because THEY made bad loans, they are in trouble because they bought assets BACKED by bad loans made by shady companies like Countrywide. These assets have become unmarketable because their value is unknown; no one wants to buy them and so the banks cannot get money to lend.

All that said, the government does not really DO this type of lending, and it is BETTER if our private banking system, which is set up to do this, can function again.

I think the best solution is for the government to buy and hold these unmarketable assets while the underlying loans are slowly repaid over time. Also, the government should enact new regulation to prevent this situation from ever happening again.

[HamdenRice]

6. "direct credit for employers and manufacturers"-- That's been the biggest part of the bailout

Someone upthread already mentioned this but here are a few more details.

There are actually several bailouts. TARP is capital infusion into banks and is the most widely known, although the amount so far is "only" $350 billion.

The biggest part of the bailout has been by the Fed. The Fed injected up to $1.8 trillion into the commercial paper market. That was direct purchases of short term debt by a variety of corporations. We don't know which, but manufacturers and other employers routinely use commercial paper to fund payroll and inventories and even out cash flow. For example, companies get revenue all month, but pay payroll once, twice or four times a month; they need to borrow to "even out" their cash positions. In fact the freeze of the commercial paper market in September was why so many people thought a complete economic collapse could happen any moment.

There are two sides of the commercial paper market -- the borrowers (issuers) and the lenders.

Commercial paper is like a post dated check. If I'm a corporation and I need quick cash, I write a "check" (or issue commercial paper) for $100,000 that is dated 30 days from today. I sell that check at a discount -- maybe for $99,900. Someone buys that check. I now have $99,900 to meet payroll or buy inventory. 30 days from today, the buyer comes to me and demands payment. I pay back the $100,000. The "lender" has made $100 in interest.

The lenders in this market were "money market funds" which were ultra safe mutual funds that are treated like bank accounts by depositors, many of whom are retirees, but also other companies with excess cash. Money market funds are known for never, ever losing money. There were about $4 trillion in money market fund deposits as of September.

In mid September, Lehman defaulted on its commercial paper meaning that it could not pay commercial paper checks that were coming due, so money market funds lost that money. Several money market funds announced that they had "broke the buck" which meant that if you deposited one buck in a money market fund, you would get back less than a buck.

There was a run on money market funds, which lost upwards of a trillion dollars in a few day. Here in New York City, thousands of people lined up to take their money out of money market funds, as well as banks and other financial institutions. If that run had continued, companies all across the nation would not have been able to sell commercial paper for payroll and inventory and basically the American economy would have shut down overnight.

The Fed stepped in to guarantee money market funds. But the funds still wouldn't buy any more commercial paper.

So the Fed began buying commercial paper -- the equivalent of making direct loans to employers. That money has been recycled over and over since September and is probably the biggest and most effective part of the bailout.

All indications are also that the Fed made billions in interest, so that part of the bailout has actually been profitable to the government.

As the money markets return to normal, the Fed has eased itself out of the market, but still is has hundreds of billions in commercial paper transactions.

[Kaleko]

7. That is one of the clearest explanations of the different bailouts I've ever seen.

I wish more people would read your post and comment - if they have the expertise to judge its merits, that is.

[HamdenRice]

8. One important correction!

Re-reading my post, I wrote that the money markets "lost" a trillion dollars in a day, but what I meant was that a trillion was withdrawn by depositors in a day. Those withdrawals were the "run" on the money markets.

As for your compliment, thanks. But when I post explanations like these, I get accused of being an undercover "Goldman Sachs shill" so the motivation to continue posting tends to wane.