This is probably wrong in so many ways, but why are we helping the bad financial institutions? Wouldn’t it make more sense to help out the good ones?
I think, first of all, that the plan is not to simply give away the $700 billion. Instead, the U.S. Treasury will take over bad mortgage investments. I think the way this works is that if the government buys $100 million in bad mortgage investments and, say, only gets back 75 cents on the dollar, the government will have spent $25 billion to add $100 billion in liquidity to the economy. At that rate, spending the full $700 billion will free up $2.8 trillion from bad investments. (I have no real idea if these figures make sense.)
Second, as I understand it, the big fear in this crisis is that a series of institutional failures will cause a credit crunch that makes it hard for companies to operate from day to day and impossible for them to expand. This could cripple production and produce a huge involuntary contraction in our economy. Preventing this credit crunch is why we want to add liquidity by pouring in cash.
But why do we have to pour cash into the bad banks? Wouldn’t it add just as much money to the credit markets if we poured the money into the successful banks?
As for the bad banks, we just let them bleed to death in the street. The remaining banks, now flush with U.S. Treasury cash, will fill in the gaps and prevent a credit crunch.
This solves the credit crisis, avoids rewarding financial institutions for their failure, and because we’re lending the money to financial institutions that have not driven themselves into the ground, probably costs less.
One of the creeds of the economist is that there’s no such thing is a free lunch, and this sounds like a free lunch to me. That means I’m probably misunderstanding something important about financial markets, and my plan is hugely flawed.
But I’ll bet it’s not the craziest plan you’ll hear before this is all over.