Bail out banks, not people
I can remember a time when people said that the US government should bailout people (read: the owners of the mortgages that were going bad) and not banks (which owned the mortgages). I disagree, and with the Spanish bailout playing out, I’ll take the opportunity to explain why.
Firstly, banks, unlike mortgage owners, are susceptible to a bank run: banks borrow short and lend long. They’ve taken your money with the promise to give it back whenever you ask but bought assets (loans of one kind or another) that payoff over a longer period of time with that money. They do not have – in their vaults – enough cash to fulfill their promises if all their depositors turn up at the same time – to operate, they’re depending on their depositors doing no such thing. You, the depositor, know this. You know that if all the other depositors turned up demanding their money back – for good or bad reasons – the bank will go under (all those assets cannot be sold at once except at a steep discount) and you’ll lose all your money. So, you also stand in line to get your money back, which worsens the bank run. The heightened possibility of a bank – perhaps even a completely healthy one – going under results in it actually going under. And a loss in faith in one bank can spread to others (partly due to panic, partly due to the fact that banks lend huge sums of money to each other) causing the entire financial system to go down, ushering in a credit crunch and depression that makes 18% unemployment look like the boom years.
On the other hand, refusing to lend to mortgage owners doesn’t have the same impact – the US government didn’t help them out and no-one thinks that’s what caused the recession there. That’s because mortgage owners have borrowed long and – I cannot emphasize this enough – are not the channels through which credit flows in an economy.
But wait, say the critics. Suppose that, instead of giving money to the banks, the US gave the money to the mortgage owners, who could then use it to pay off their debts, which would also have prevented a bank run.
Ah, but the US didn’t give the money to the banks. TARP – the program that saved the financial system – combined asset purchases with loans in exchange for equity (effectively nationalizing banks, insurers and, in one odd case, an automobile maker). Initally expected to cost the taxpayer $300 billion, it end up costing far less (around $40 billion, the last time I checked) and actually turned a handsome profit from it’s involvement with the banks – most entities have now repaid their loans and purchased their equity back from the government. As I’ve said before, the US government acted like a superbank: helping banks to weather out a bad period, the way that banks (ought) help out companies.
I can’t imagine mortgage owners, who were defaulting on money they owed the banks, repaying money they owed to the government. The banks repaid what they owed. The mortgage owners would not have. The costs would have been much higher, not to mention the logistical difficulty of the government dealing with millions of individuals instead of a handful of institutions. You could still justify loans to homeowners on welfare grounds: that it would help them, but you’re no longer in “prevent the apocalypse” territory and are comparing apples to oranges.