The Wall Street banks were on life support in the fall of 2008. Without trillions of dollars of government loans and guarantees (much more came from the Fed than the TARP money that went through the Treasury), they would be dead, deceased, pushing up daisies, out of business. The boys and girls getting those huge paychecks on Wall Street were at Uncle Sam’s doorstep pleading for help. There was no one else to save them from destitution.
In this context there were three main choices. One was to drag out Mitt Romney and give them a lecture about the free market and tell them the government is not about giving people stuff. In this case the banks go under leading to a full-fledged financial melt-down. In this story, the economy certainly takes a bigger immediate hit, but the advantage is that we have a Wall Street free world. Goldman Sachs, Citigroup, Morgan Stanley, J.P. Morgan and the rest would be history. They are in receivership, waiting to broken up and sold off. This parasitic sector that has led to so much waste, corruption and inequality is no longer a drag on the economy. Consider this short-term pain for long-term gain. (Just kidding about the Romney part, he supported the bailout.)
The second choice is hand over the money, which is the route we took. Oh yeah, Congress did put conditions on the money, but we know that was just for show. One of the most disgusting things I’ve seen in my years in Washington were the excellent stories on how executive compensation was treated in the TARP that the Washington Post and Wall Street Journal ran after the TARP passed.
Both articles featured comments from compensation expert Graeff Crystal who explained that the government could have changed compensation patterns on Wall Street forever (the Wall Street boys needed the money), but Congress instead took a pass. It would have been great if Crystal’s views were part of the public debate before the bill was passed.
This brings up option number 3, hand the money over but with real conditions. Congress could have said that banks that got TARP money, funds through the Fed’s special lending facilities, or benefited from the various Treasury and FDIC insurance commitments had to:
a) strictly limit all pay in all forms for the next five years;
b) set up a clear, legally enforceable plan for writing down underwater mortgages on their books;
c) agree to a breakup schedule that would get them below “too big to fail” size by a set date.
To my mind, option #3 was clearly the best route since it would fix the financial industry and avoid the crash that would result from going cold turkey in option #1. But let’s say that the choice is just the full crash in option #1 or the handout in option #2. In order to seriously decide between these we need some basis for assessing the size of the downturn. Saying that the short-term impact would have been worse in option #2 doesn’t tell us anything about the proper policy choice. We pay short-term costs for long-term benefits all the time. We need the terms of the trade-off.
In ths respect, the commonly claimed “second Great Depression”scenario is, to use a technical economic term, “crap.” The first Great Depression, by which I mean a decade of double-digit unemployment was not locked in stone by the mistakes made at its onset. There was nothing that would have prevented the government from having the sort of massive stimulus spending that eventually got us back to full employment (a.k.a. World War II) in 1931 instead of 1941 and without the war. The fact that we remained in a depression for more than a decade was due to inadequate policy response.
In this respect, to claim that if we let the banks collapse we would have been destined to suffer a decade of double digit unemployment is absurd. That would only be the result if we continued to have bad policy, not just in 2008, but in 2010, in 2012, right through to 2018.
The serious question is how bad could we reasonably expect the downturn to have been if we had gone the cold turkey route. The place to look for insight on this question is Argentina, which went the financial collapse route in December of 2001. This was the real deal. Banks shut, no access to ATMs, no one knowing when they could get their money out of their bank, if they ever could.
This collapse led to a plunge in GDP for three months, followed by three months in which the economy stabilized and then six years of robust growth. It took the country a year and a half to make up the output lost following the crisis.
While there is no guarantee that the Bernanke-Geithner team would be as competent as Argentina’s crew [indeed, subsequent events have shown that they are not -- Lex], if we assume for the moment they are, then the relevant question would be if it is worth this sort of downturn to clean up the financial sector once and for all. I’m inclined to say yes, but I certainly could understand that others may view the situation differently.
Anyhow, this is the debate that we should have had the time and at least be acknowledging in retrospect.
We had the bastards down in the fall of 2008, and we didn’t hit them with the chair. A century from now that failure will be considered the key turning point in the transition of the U.S. from a democratic republic to a full-on oligarchy.