Rising from the ashes: Why bailouts ultimately hurt

It was just a couple of years ago. The housing market wasn’t doing so hot, and these things called derivatives were supposedly making things very difficult for the banks. President Bush stood behind a podium and addressed the American people. He told us that the government needed to buy these derivatives because it would help the banks, and then when the value went up, the government could sell them. It sounded fine.

What we got was something else entirely as various banks began to fail. Then auto companies were barely limping. There was panic in Washington, and they said we simply had to do something. But did we?

Economic matters are always tricky, and there’s always another point of view that will disagree with whatever you think. However, the biggest mistake we made was believing in the idea of “to big to fail”.

Take a hypothetical bank called Bank of Tom (BoT). BoT starts out as a small community bank, but grows and grows. Thanks to government assistance, it becomes one of the largest banks in the United States. It buys up smaller competitors with loans from the government, as well as lobbies Congress for laws that are favorable to it while hurting smaller competitors. It’s massive, employing thousands and controlling a huge part of the market.

Then the economy goes to crap and BoT is in serious trouble. If it’s going to stay, it needs help from the government. This is where we found ourselves just a couple of years ago. We already know what can happen if BoT gets the help. The economy stagnates for at least a couple of years and the company continues doing business as it always had, confident that they’re “to big to fail”. But what if we had taken the other road? What if BoT had been allowed to fail?

First, the suck factor initially would easily have been higher. Those thousands of employees are simply part of the problem that would burst forth out of that. You’d also have some people lose money despite FDIC, simply because they had savings above the level that FDIC will cover. But that’s the short term. Long term is a different picture.

You see, first, Congress would have seen the chaos that huge megabanks can cause when they collapse and be hesitant to allow the governemt assist another bank get that big. (I’m going to pretend that they’re also smart enough to not pass laws to prevent it…deluded, I know, but play along with me)

Now, without BoT running around squashing the competition, smaller banks have a fighting chance. New banks rise up to meet the demands left untouched in the wake of BoT’s collapse. New jobs are created, often taken by the former BoT employees. As each bank has it’s own support structure and management hierarchy, you actually create more jobs than if you had those exact same customers needs being met by a single entity. In time, the short term suck factor would be gone, and you would find more prosperity for more Americans.

Customers would win because there are more choices for their banking needs. Employees would win because more jobs being available makes experienced workers more in demand and able to negotiate for higher wages without a union. The banking industry would win because as more banks compete, customer service would vastly improve and create a better impression on the customers, replacing the image of the megalomaniac banker intent on crushing the little guy

It’s what we call a “win-win” situation. New competitors rise from the ashes like the Phoenix of legend, creating something more glorious than the massive corporations that currently dominate so much of the American business landscape and corrupt the American political system seeking favorable regulations that hurt smaller businesses or block new competitors from entering the market.

Yes, the bailouts hurt us. They hurt us far more than they know.

 


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