Nov 12, 2008 7:25 PM
Why The Bailout Isn’t Working
Treasury Secretary Hank Paulson announced today that the government will not be purchasing troubled assets from banks, as they had previously planned to do. This is a startling reversal, given that this was the centerpiece of the original bailout package. Such an abrupt about-face is hardly encouraging as it begs the question of what exactly the government has been doing all this time and calls into question whether those in charge really have any idea how to solve our problems.

It is common knowledge by now that the root cause of our financial difficulties is excessive debt. Across the whole economic landscape – from individual homeowners to corporations to the government – everyone dug themselves into financial holes that they are now unable to climb out of. This being the case, doesn’t it seem odd that the government’s solution to the crisis is to borrow even more money to shower upon the financial sector in hopes that they will start lending again? This is like treating a patient suffering from alcohol poisoning by force-feeding him another drink.

Yes, functioning credit markets are an essential part of a modern industrial economy, but we seem to have lost sight of the fact that the ultimate health of an economy is based on individuals and corporations creating, buying, and selling valuable goods and services. Yet virtually all of the money the government is spending on its rescue efforts are aimed at Wall Street rather than Main Street. The credit markets ought to be the servant of the real economy, rather than the other way around.

Does nobody find it strange that, while hardly anyone bats an eyelash at the latest hundred-billion-dollar bailout of a bank or insurance company, we hear nothing of plans for increased public spending on infrastructure, technology, or education? Is it really better use of taxpayer money to pour countless billions into a financial black hole like AIG rather than investing in technology and education which will improve the long-term ability of American workers and corporations to compete in the global economy? What if, instead of spending a trillion dollars to help banks avoid the consequences of their own foolishness, we spent that money on building bridges and roads, developing alternative energy, and retraining American workers with outdated skills?

Forgetting for a moment the question of fairness, let’s consider from a purely practical point of view which approach to rescuing the economy is most likely to work.

All of the measures aimed at repairing the credit markets are based on the presupposition that once banks stop the financial bleeding they will resume “normal lending”, thereby rescuing the economy. The rationale underlying this argument is based on a very questionable assumption. Even if banks are willing to lend, borrowers need to perceive attractive uses for capital or they will have no incentive to utilize the available credit. After all, if someone offered you a zero interest loan to purchase real estate right now, would you do it? Two years ago virtually everyone would have answered this question in the affirmative, but things have changed since then.

In the absence of solid investment opportunities, the government can print all of the money it wants, but it may still be incapable of stimulating the real economy. I would argue that the trauma of the last several months has fundamentally changed public attitudes to debt and that a return to “normal lending” is neither possible nor desirable. Do we really want to go back to a state in which people borrow as much as they possibly can in order to buy bigger TVs and homes they can’t really afford?

If, on the other hand, the government announced that it was going to spend a trillion dollars to repair roads and bridges, build wind farms, and retrain American workers, the stimulative effects would be far more certain. Millions of jobs would be created and those millions of employees would have an increased ability to spend and invest. This seems like a far more effective way of battling the current crisis than pouring money into banks and insurance companies in the hopes that they will return to business as usual.

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