I really hope we can have a real discussion on this topic. The question is simple: It's 2008. TARP is never created or employed. None of the banks that face collapse are bailed out. Zero government intervention. Bear Stearns. Lehman Brothers. Washington Mutual. Citibank. Morgan Stanley. AIG. Freddie Mac. Fannie Mae. Goldman Sachs. What happens? In a nuts-and-bolts sense, what happens? What happens when a bank dies? What happens when an insurance provider dies? What happens when a bunch of them, or most of them die? This is an honest question, I sincerely want to know, because I don't know the answer. -What happens to their holdings? Where does the money go? Does it vanish? -What happens to the savings and checking accounts of the average American? It would have gone beyond the scope of the FDIC, no? In asking this question I am personally completely uninterested in having any personal political or economic agenda advanced or defended or attacked. I truly want to know, functionally, what happens when a bunch of huge banks collapse? Do the assets just vanish? If they don't, where do they go? WHAT THIS THREAD IS ABOUT -The functional reality of the collapse of a financial institution. -Conjecture on what would have happened from 2008 on if there were no bailouts.
Would the banks have ultimately failed? Obviously Bear Stearns/Lehman Brothers failed. WaMu was purchased before TARP. CitiGroup, BOA, AIG, and the Auto industry were the big companies that in reality got bailed out. BOA never should have been allowed to acquire Merrill Lynch and Countrywide in the year leading up to TARP. If it wasn't for those acquisitions, BOA would have had no problem. Personally, I think CitiGroup should have been broken into pieces.
Without TARP, the contagion affect would have destroyed much of the financial system worldwide. Leverage levels were atrocious so disappearing assets due to counter-party issues and fear would have stopped capital completely as no one would have trusted that the guy on the other side of the overnight lending would be there. Investment banks aren't covered by FDIC, but it would've gone belly up as there was less than $100 billion in TARP, which pales in comparison to deposits of the few large banks in the US. AIG would have blown up so a significant number of life insurance, insurance and pension plans would have blown up and with the collapse of Fannie/Freddie plus the death of the secondary mortgage market would've killed any demand for housing resulting in a great depressionesque housing foreclosure rate (maybe not as high as hit 40% during the great depression). World would've looked pretty bleak. I think Paulson and Bush put their principles aside and made a ballsy hell of a decision to save our country and world from a financial meltdown. It wasn't popular but it was extraordinarily effective in its simplicity and not only did it save the financial system but the banking side of TARP has actually made money and they may eventually get their money out of AIG as well. The biggest losers so far are Fannie Mae and Freddie Mac which have already cost taxpayers hundreds of billions of dollars and exposed them to around $6 trillion in mortgages. Unlike most fiscal conservatives, I wasn't completely against the auto bailouts as in the larger scheme of things the amounts were small compared to the overall bailouts across the board though I wasn't pleased the way bondholders were treated in GM's re-structuring and I believe giving the unions that disproportionate ownership and the government influence will doom the executives at GM to catering to government and Unions as opposed to shareholders making it unlikely that the people will get their money back on their investment anytime soon.
The problem is that all these institutions had high degrees of leverage and counterparty risk to each other. As one or two disappeared it would erase significant parts of other companies balance sheets, which would in turn cause other problems. People would also panic and pull money out of institutions and cause runs on perfectly good banks. The thing people don't realize is that a bank is an institution built on trust that is subject to contagion. People deposit short-term funds and the bank makes long-term loans, so if people pull their money, a bank will fail. When people see one bank failing, they fear their bank will fail as well and this causes systemic failures of the banking system.
The below did happen, and it was only stopped by intervention followed by rumors of the intended bailout (when Hank Paulson got on a knee and begged Pelosi, etc): http://www.boingboing.net/2009/02/09/rep-kanjorski-550-bi.html Rep. Kanjorski: $550 Billion Disappeared in "Electronic Run On the Banks" The Capital Markets Subcommittee Chair, Rep. Paul Kanjorski of Pennsylvania, tells C-Span how the world economy almost collapsed in a matter of hours. At 2 minutes, 20 seconds into this C-Span video clip, Kanjorski reports on a "tremendous draw-down of money market accounts in the United States, to the tune of $550 billion dollars." According to Kanjorski, this electronic transfer occured over the period of an hour or two. Kanjorski: "The Treasury opened its window to help. They pumped a hundred and five billion dollars into the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn't be further panic and there. And that's what actually happened. If they had not done that their estimation was that by two o'clock that afternoon, five-and-a-half trillion dollars would have been drawn out of the money market system of the United States, would have collapsed the entire economy of the United States, and within 24 hours the world economy would have collapsed." "It would have been the end of our political system and our economic systems as we know it." People tend to call people who say that this stuff was going to cause a total meltdown fearmontgers, but for anyone who was really paying attention and watching what was going on, total collapse was the path we were on. Beyond the financial system, you also had a total freeze of the credit system - again, that actually happened WITHOUT the collapse. If you take trillions out of the system, the problem becomes far worse.
Great Point Major. Even rates for overnight paper for utility companies to run their business to willing consumers to buy power shot up to astronomical rates. Non-financial industries would've felt the complete lack of credit and capital and would've had massive layoffs combined with what the lack of consumer credit and bank failures would have done to consumer spending which accounts for a huge part of US GDP. Businesses would have gone under, layoffs would have been massive and that combined with the entitlements people feel today would've created huge civil unrest and could've destroyed America.
I acknowledge Major's point and understand it. I accept it. Yet a part of me would have liked to watch it all burn.
Just a separate observation, if the alternative was so terrible (and I reckon it's true) then what on earth is to stop the dangerous moral hazard that it creates? Banks know that they will be lent money from the Fed in times of crisis, but how far has the Dodd-Frank act actually done to quell this?
+1 I have a sinking feeling that all we did was set ourselves for worse collapse in the future. Establishment wonks will never see it that way, but disrupting the natural lifecycle and balance of business and finance is... unsettling at best, and dangerous at worst. You have to pay the piper eventually, there must be consequences. How can you have your pudding if you don't eat your meat, etc.
You are right. There is no way to be certain what would have happened, but we know it fixed itself at a relatively low cost since most of the money they needed. Very amazing how quickly all of these companies went from on the brink of failing to highly profitable again. I think the government realized FDIC couldn't shoulder the burden of more national banks failing. I think banks need to be smaller. When a handful of companies can bring us on the brink of failure, that is a serious problem.
Moral hazard is frequently-cited but really poorly understood in terms of real-world conseuqences. it's very difficult to quantify/qualify and tends to be tossed around alot. Dodd Frank was a grab bag of reforms, mostly centered on capital & margin requirements, limiting risky forms of trading, the CPFB, greater transparency and other stuff; but on the moral hazard front, I suppose you could argue that the new compensation rules, the ability of the Fed to step in earlier for nonbank financials make it all less likely that people are going to want to pull a Stanley O'Neal (though I doubt people want to consciously emulate him anyway? That's one of the things i don't like about the moral hazard argument...)
I think that is why the Federal Reserve was created: to prevent such a large runs on the banks, and subsequent failures. The link weslinder posted is about the last major banking crisis before the creation of the Federal Reserve. After bailing out the US government twice, JP Morgan and various other banking executives got together with congress and the president and created the Federal Reserve. The financial sector that we have today seems extremely complex. Only in the past 4 or 5 years have I been reading about the repo market; perhaps the largest financial market in the world. Several trillions of dollars worth of short-term security backed loans are made everyday in the repo market. The 2011 US Treasury default would have sent the market into extinction. American currency is like the world's gold: some countries use it as an official currency, some peg their currency to the dollar, and it is the most demanded currency. It in many ways is our largest export; in fact financial services make up the majority of exported services for this country.
This is why it didn't matter what Congress did: <iframe width="420" height="315" src="http://www.youtube.com/embed/oUpXDZFtEHw" frameborder="0" allowfullscreen></iframe> The Fed is always around to bail out their big banker buddies with Trillions printed out of thin air....
The problem is that you can't have a worst collapse. This would have destroyed the entirety of western finance - there's no real end result worse than that. So the choice was to guarantee a collapse, or possibly have the same collapse down the road.
Listening to Dennis Kucinich is generally a bad idea. The Fed didn't give anyone $8 trillion dollars. It's already been debunked many times, even on this board.
I don't see how that is provable, nor do I believe it. It can always get worse. There is no "worst", IMO. (Unless you consider the utter destruction of the universe as a possibility, I suppose)
I don't particularly have a problem with the fact that the banks were bailed out, my problem is that we are letting them get away with basically the same $hit still. Derivatives are a major major problem...one of many Case in point...BOA, due to downgrades that affect collateral obligations, moved their $76 trillion dollar derivatives book from the holding company to the banking division...offset by $1 trillion in retail deposits. Sure, the money is insured via the FDIC, but see how quickly you get your money from the FDIC if the $hit hit the fan. No one batted an eye when this happened. The problems that led to the bailout basically have not been corrected and any time you mention increased, EFFECTIVE regulation, one half of the country cries foul.
