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While it is true that exposing Wall Street mega banks for what they are—bankrupt—may cause a severe short-term jolt to global financial markets, such a short-term turbulence would be a necessary price to pay for a “clean break” from the current financial stalemate and a long, protracted economic malaise. It would also serve as an effective way to prevent massive redistribution of resources from taxpayers to Wall Street gamblers. In the history of socio-economic developments such cataclysmic but inescapable shocks are variously called “regenerative or creative destruction,” “shock therapy,” or “birth pangs” of a new dawn and a fresh start.
The alternative to a painful but swift cleansing of the mega banks’ toxic assets is to keep these technically bankrupt banks on a financial life-support system that, like parasites, would suck taxpayers’ metaphorical blood, drain national resources, and eventually corrupt or devalue the dollar. What’s more, there is no timeframe as to how long these mega banks should or would be kept on the costly crutches provided by the taxpayers, which means the financial stalemate and economic paralysis can go on for a long time. Two historical precedents can be instructive here.
In the face of the Great Depression of the 1930s, the Hoover administration, using the “too big to fail” scare tactic currently used to bail out the insolvent Wall Street Gamblers, created the Reconstruction Finance Corporation that showered the influential bankers with public money in an effort to save them from bankruptcy. All it did, however, was to postpone the inevitable fate of the banking industry: almost all of the banks failed after nearly three years of extremely costly bailouts policies.
In a similar fashion, when in the mid- to late-1990s major banks in Japan faced huge losses following the bursting of the real estate and/or lending bubble in that country, the Japanese government embarked on a costly rescue plan of the troubled banks in the hope of “creating liquidity” and “revitalizing credit markets.” The results of the bailout plan have been disastrous.
Although the amount of sour assets has never been disclosed, it is obvious (in retrospect) that such worthless assets must have been colossal. For despite a number of huge bailout giveaways, no noticeable improvement in the ailing conditions of Japan’s troubled banks is visible.
Not surprisingly, more than a decade after the debt overhang of Japan’s troubled banks first came to surface in 1997-98, most of the affected banks continue to be vulnerable, the nation’s credit market still suffers from a lack of trust, and the broader economic activity remains anemic.
So, the undisclosed, tightly-kept-secret tons of toxic assets simply cannot be bailed out. Not only will efforts to do so fail, they are also bound to make things worse by draining public finance, redistributing national resources in favor of incompetent and irresponsible financial institutions, accumulating national debt, weakening national currency, and prolonging economic crisis.
Only by burying the oppressive deadweight of mountains of fictitious assets and cleansing the market off their toxic effects can trust be restored in credit markets. This requires opening the books of the troubled financial institutions and letting them go belly up if they are technically bankrupt. As William Greider of The Nation magazine puts it, “Facing facts will be painful, but it's better than continuing a costly charade” [5].
The current policy of keeping the toxic assets of insolvent financial institutions on costly crutches is nothing short of price fixing. The logical way to realistically evaluate the price of these assets is, therefore, to do away with the current policy of price fixing and let market forces determine the price. As Mike Whitney points out,
"The appropriate way to establish a price for complex securities in a frozen market is to create a central clearinghouse where they can be auctioned off to highest bidder. That establishes a baseline price, which is crucial for stimulating future sales. . . . Bernanke [the head of the Federal Reserve Bank] would be better off letting the market decide what these debt-instruments are really worth. There are always buyers if the price is right" [6].
While pulling the plug on the insolvent banks and letting them go belly up may cause short term convulsions in financial markets, it will have several advantages that would far outweigh such temporary pains.
To begin with, this would shorten the wrenching economic crisis and usher in a clean start. Second, it would avoid rewarding mismanagement, inefficiency and irresponsibility. As Jim Rogers, founder of the Quantum Fund, points out:
"What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent. . . . What’s happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics.
“Governments are making mistakes. They’re saying to all the banks, you don’t have to tell us your situation. You can continue to use your balance sheet that is phony…. All these guys are bankrupt, they’re still worrying about their bonuses, they’re still trying to pay their dividends, and the whole system is weakened [7].
Many smaller but financially sound regional and community banks could greatly benefit from the opportunity to buy out the realistic, market-based or devalued assets of the insolvent mega banks. Not only will this benefit the healthier financial institutions, it will also lighten taxpayers’ bailout burden.
Third, in light of the fact that the bailout giveaway dollars represent a subtle redistribution of national resources from taxpayers to Wall Street gamblers, declaring these gamblers bankrupt would protect taxpayers from having to shoulder the costly bailout burdens, thereby helping to protect the nation from further plunging into debt. There is absolutely no reason why taxpayers should bailout giant banks, insurance companies, investment banks, and hedge funds.
