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October 01, 2008

Inside the Bailout Backlash

Catherine New
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This week, Columbia Business School faculty members responded to the failure of the Treasury’s bank rescue plan to pass the House. The overall sentiment: something needs to be done, but what form it should take, and what kind of support it will have, is still unclear. On Sept. 29, Prof. Suresh Sundaresan offered his insights on National Public Radio’s Planet Money (listen to audio):

It’s a bit of a shock that the rescue plan was rejected; over the last several days some tight provisions were added on… and safeguards were added and we had two extremely informed and knowledgeable folks — the Secretary of the Treasury and the Chairman of the Federal Reserve — pleading for this assistance. … I could be wrong completely in the sense that the stock market picks up and libor goes back, but I find a low possibility of that happening unless something is done by Congress.

On Sept. 30, Prof. David Beim spoke with Tom Ashbrook on NPR’s show On Point (listen to audio), saying:

What we need to do is clarify what the goal of the bailout is. If the administration had given us a more clearly focused package, it would have attracted more support. A bailout is perfectly ok if it’s focused liquidity. Central banks have been providing liquidity to financial systems for 200 years and turning illiquid assets into cash at fair value. They lend to banks against good collateral and they also buy assets from banks at fair prices and doing that involves no particular cost to the government. If the bailout is focused on that, I am perfectly fine with that. … But if you’re trying to fix solvency issues and give away money to people who brought you the problems in the first place, then it is terribly wrong.

Writing in the New York Times, “Lessons From A Credit Crisis: When Trust Vanishes, Worry,” David Leonhardt cited an anecdote from Prof. Frederic Mishkin on the public’s growing skepticism and lack of support for the bailout.

In 1929, Meyer Mishkin owned a shop in New York that sold silk shirts to workingmen. When the stock market crashed that October, he turned to his son, then a student at City College, and offered a version of this sentiment: it serves those rich scoundrels right. A year later, as Wall Street’s problems were starting to spill into the broader economy, Mr. Mishkin’s store went out of business. He no longer had enough customers. His son had to go to work to support the family, and Mr. Mishkin never held a steady job again.

Frederic Mishkin — Meyer’s grandson and, until he stepped down a month ago, an ally of Ben Bernanke’s on the Federal Reserve Board — told me this story the other day, and its moral is obvious enough. Many people in Washington fear that the country is starting to spiral into a terrible downturn. And to their horror, they see the public, and many members of Congress, turning into modern-day Meyer Mishkins, more interested in punishing Wall Street than saving the economy.

Is the public’s skepticism of the bailout deserved or misplaced? The Senate is expected to vote Wednesday night on the Treasury plan. Please share your comments.

Comments

by Anjum Rokadia | October 02, 2008 at 3:18 PM

The public's skepticism of the bailout stems from the fact that it's been bomarbarded with a sense of urgency without any real explanation of how the credit crisis affects them personally.

The hit to Main Street will lag behind the hit to Wall Street. Therefore, the government needs to delineate how the lack of credit inevitably will adversely affect small businesses, student loans, consumer purchases, etc. and how this will lead to a widespread economic downturn and increasing unemployment.

More importantly, the government needs to reassure the public that the bailout is a bailout of the economy as a whole, not a bailout of Wall Street. As such, the bailout needs to focus on liquidity, not solvency.

The sole purpose of the bailout should be to inject liquidity into the system to keep credit available to deserving ventures. It should in no way imply an intention to save badly performing banks from going under.

Keeping with this purpose, the government must emphazise protecting the taxpayers' money above all else. This can be best achieved by buying equity to expand bank capital rather than by overpaying for assets that can't be accurately valued.

A few people recklessly managing other people's money got us into this mess. Now the public is being asked to trust a few people to manage their money to get us out of this mess. Consequently, it is imperative that it is the public's interest, not Wall Street's, that is kept at the forefront.

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