Treasury Continues to Fumble -- Will They Ever Get it Right?

By Dean Baker, Comment Is Free. Posted March 18, 2009.

These and other measures have restored some measure of stability to the financial system. Now that we have these measures in place, is it still true that we can't subject Citigroup, Bank of America or Goldman Sachs to a managed bankruptcy (aka "nationalization") without the world coming to an end?

With a managed bankruptcy, all the insured deposits would be fully covered. However, the government would only repay bondholders a portion of their investment, depending on how severe the banks' losses are. By not compensating bondholders in full for their losses, the government could save taxpayers hundreds of billions, perhaps even trillions, of dollars.

In addition, a managed bankruptcy would also help to address the problem of moral hazard created by the bailouts thus far. Investors did not pay adequate attention to the health of banks and other large financial institutions like AIG because they assumed that the government would bail them out if things went badly. If the government makes these investors eat some of their losses, maybe they will put more thought into their investment strategies in the future. This could also let some big investors make some of the "sacrifices" for which fiscal conservatives -- including some big investors -- are so eager.

The silence of the fiscal conservatives on the vast sums going to the banks is hard to understand. After all, how can someone get so upset about the prospect of $200m being spent to re-sod the National Mall in Washington, but be unconcerned when $160 billion -- almost 1,000 times as much money -- goes out the door to AIG?

The sums of money going to bail out the financial industry dwarf the waste and pork that get John McCain and other budget hawks excited. Yet they are strangely calm about the bailout money. In fact, the amount we spent patching the financial system could well be large enough to make the Social Security system fully solvent over its 75-year planning horizon, yet we barely hear a peep from the Peter Peterson Foundation and its merry band of anti-Social Security crusaders.

The only answer we ever get in response is that we have no choice. But just six months ago, Henry Paulson, Ben Bernanke and Timothy Geithner thought we could make a much more extreme choice. They were wrong then, but they are not stupid. We should go back to the bankrupt Lehmans and see if we can do it right this time.

See more stories tagged with: bailout, financial crisis, lehman brothers, aig, ecnomy

Dean Baker is co-director of the Center for Economic and Policy Research.

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