Bailouts and stimulus

By Carl

A lot has been tossed around Blogospheria and Blogtopia (© Skippy) about the stimulus package passed last week in the House and under consideration by the Senate, as well as about the bank bailout trial balloons.

The usual suspects are chiming in from both sides, angry about some such or other. From the right:

Yes, the stimulus is less than a trillion -- $819 billion in the version passed by the House. But that's still a bigger total than a million a day since the first Christmas.

That's a soundbite that is going to resonate.

And from the left:

This is some serious bullshit that you're about to lay down and it will destroy your presidency. I'm being totally serious. What's more, it will destroy the Democratic Party's reputation as being the party that does a better job of taking care of the middle class and the poor.

First, it's interesting that the right wing has fixated on "$1 million a day since Jesus' birth" when it comes to spending on their neighbors yet have absolutely no problem in that figure being spent on Iraq, a people most of them will never meet, much less have over for dinner. It's a childish argument to make, and please, Republicans, keep making it so we can keep hammering you about Iraq!

I'm guessing a small amount of economic security is worth less than some nebulous "safety from terrorism," which has to allow for that trope to be legitimate, to boot.

As well, the arguments from Sadly, No! with regards to the "bad bank" proposal, while legitimate, ignore the environment and history this proposal was made in. Let's take a quick look at how this is supposed to work:

The bad bank clears the toxic assets off the books of banking systems by buying them at market prices and forcing write downs by the banks. A good bad bank forces banks to write down their bad assets and cleanse their balance sheets with those made insolvent being recapitalized, nationalized or liquidated by the state. But it is equally possible to use a bad bank to buy the banks' toxic waste at inflated prices so that the bank can start lending again. That's when it becomes a bad bad bank.

The Obama proposal would buy some assets at inflated valuations, what the banks are carrying them at. Other assets would be bought at current market values, meaning the banks would take a loss, and a third class of assets would be left on the banks' books for them to worry about.

Here's the problem S,N!'s argument misses: Banks can only lend based on a capitalization ratio. That means, if they have $1 million in invested capital (shares outstanding), they can only lend a proportion of that capital. Time Magazine reports that the loan-to-capital ratio is currently 30-1 at some banks. That million dollars of capital produces $30 million in loans.

The kicker, the really nasty bit of this unbalanced scenario? Any loss is written off against the capital base. So if, of that $30 million lent, $500,000 goes bad, your capitalization is now only $500,000 and oops, you are in violation of any number of banking regulations, since you maintain $29.5 million against a $500,000 capitalization. You have to sell off some of your other mortgages in order to restore your minimum base.

But to whom, in a market where ALL banks are suffering the same scenario? Worse, even if you could sell off loans made, you'd end up selling off only the really good ones, the ones that have the best shot at being paid back, so now you are in even more danger of being in default.

Your only option is to shut down. You announce you're closing. Your depositors, at least those without insurance, make a run on you. Rumors start to pass about other banks also about to close. Their depositors take a run at those banks.

Soon, the entire banking system is shut down by presidential fiat. The FDIC has to come up with... $7 TRILLION DOLLARS.

Suddenly, a trillion doesn't seem like such a bad idea, now does it?

(Cross-posted at Simply Left Behind.)