Twofish's Blog

September 20, 2008

Two big misconceptions about the financial crisis

Filed under: china, finance — twofish @ 2:37 pm

One misconception that I’ve seen a lot is the idea that letting the banks fail would hurt only rich fat cats while having a government bailout will hurt “good honest working class taxpayers.”  In fact the situation is quite the opposite.  All of the rich fat cat corporate executives have already jumped out of the flaming wreckage of these financial companies, and if you let them fall, they’ve already taken their money and their bonuses and left.  The people will be hurt if you just let the banks fail are the creditors of the bank (i.e. people with checking accounts in them).

Now once you have the government assume the debts, then you can have Congress decide who pays for it.  The everytime a I hear about “we taxpayers” I think “I, super rich person that wants to hide behind poor people.”  Congress can decide to pay for the bailout by “soaking the rich” and I think you’d end up with a fairer answer to “who pays” than you do if you set let the banks fail.  In any case, you end up with a discussion of “who pays” that you don’t if you let things happen.

The second misconception that I’ve heard is “I’m save because my bank accounts are insured.”  This is false.  You are indeed *safer* if your bank accounts are insured, but FDIC only has about $50 billion of cash to cover $5 trillion of deposits, so if banks start failing, the government would have to fund anything anyway.  Checking accounts in insured banks are the last domino to fall, but they *will* fall if people didn’t do something about it, and the fact that we are looking at a situation were you could have mass bank failures and closures is why this is a scary situation.

And bank deposit insurance isn’t really going to help you that much if everything does fall apart.  Most people just don’t have that much money in their bank accounts.  They have enough to pay the bills and get them to the next paycheck, and most people rely on a job for their wealth.  Your checking account may be fully covered by depositor insurance, but I doubt that the account that the company that you work for uses to write your payroll check is.  This poses another problem which is time.  If FDIC runs out of money, then you will need Congress to approve a bailout package, and who knows how long that could take.  Getting your checking account money is bad if it takes a month to get the cash, and if you don’t have the cash on hand to buy groceries that is going to be a problem both for you and the supermarket.  Even using your credit card may not work, since you will have problems if the bank that runs your credit card is closed, and even if it is open, it doesn’t have much cash.

The fear of cascading failures is also why Treasuries put a guarantee on money market funds.  Money market funds are based on commercial paper which companies use to borrow working capital.  You take steel, make cars, but you need some way of buying the steel in the first place, so you borrow money with the promise that you will pay it back once you’ve made a car.  Commercial paper and money market funds are used for this, and if you don’t have this market, then no steel, no cars, no jobs.

If you want to imagine the worst case scenario just imagine yourself in front of an ATM with the it telling you that it is out of money, and having the bank tell you that your credit cards have all been cancelled because the bank is out of business, and then your employer telling you that he can’t pay you because his cash and his credit is frozen.  Once this happens then the system unravels very quickly, and the last time this happened, it took 15 years to get out of the mess.

The good news is that ATM machines and credit card systems are working now.  I can go to the corner store to get a slice of pizza.  The system is still functioning, but it took a lot of effort this week to keep it working.

Advertisements

1 Comment »

  1. You make some good points. Sometimes, however, it is just time to let a system collapse. This bailout clears the books of the surviving companies and allows them to go along their way creating more havoc. This bailout also assumes the US government is solvent enough to take on this debt.

    To me, this just extends the inevitable. The price you, your children, and grandchildren will pay for this makes that slice of pizza pretty expensive.

    Comment by Ray Davis — September 20, 2008 @ 3:20 pm


RSS feed for comments on this post. TrackBack URI

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Blog at WordPress.com.

%d bloggers like this: