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Questioning the Bailout of All Bailouts

As Charles Morris pointed out on our site Thursday, the markets are giddy over a possible Resolution Trust Corp.-like solution to this week’s big meltdown on Wall Street. The only problem, Morris explained, is that the RTC wasn’t actually a bailout and didn’t buy up bad mortgages from ailing banks.

The details don’t seem to matter on Wall Street. Bank shares are rising and the financial sector is pinning all its hopes on the biggest bailout in U.S. history as the only way out of a credit crunch that threatens to take down the market and the entire economy.

But slow down. Outside Wall Street, not everyone is impressed. As federal officials and Congress work to put together a plan, critics are claiming the whole thing is a huge mistake. In the blogosphere, even people who don’t particularly like economist and former Labor secretary Robert Reich are citing this essay, in which he calls the Bailout of All Bailouts a bad idea.

From Reich:

A better idea would be for the Fed and Treasury to organize a giant workout of Wall Street — essentially, a reorganization under bankruptcy, for whatever firms wanted to join in. Equity would be eliminated, along with most preferred stock, creditors would be paid off to the extent possible. And then the participants would start over with clean balance sheets that reflected new, agreed-upon rules for full disclosure, along with minimum capitalization. Everyone would know where they stood. Bad debts would be eliminated. Taxpayers wouldn’t get left holding the bag. And there would be no “moral hazard” incentive for future financial wizards to take giant risks with other taxpayers’ money. Congress, the Fed, and the administration shouldn’t be giving more help to Wall Street. Policy-makers should focus instead on people who really need a safety net right now — workers who have lost or are about to lose their jobs, who need extended unemployment insurance and health insurance for themselves and their families; homeowners who have lost or are likely to lose their homes, who need additional help meeting mortgage payments and reorganizing their debts; and people who have lost or are in danger of losing their savings or pensions, who need better insurance against possible loss.

They’ll be more of this today, even before a plan gets put together. I’d expect a backlash because any bailout will appear to let banks off the hook for their egregious and greedy behavior.

It will be interesting to see if the Federal Reserve and Congress can come up with something that also makes the financial sector seem to share in the pain before it can get rescued by the taxpayers yet again.

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