I’ll be the first to admit I don’t know much about economics. My layman’s understanding of the current financial crisis is that it has something to do with the financial institutions not wanting to lend money to each other, so the government is giving them a bunch of money to try to get them to start lending again. But even with these new funds, they still may not want to lend money, because they’re worried they’ll lend money to an entity that goes bankrupt and they’ll never get it back. Or something.
Wouldn’t it make more sense if, instead of cutting the financial institutions a check, the government set that money aside as insurance for their loans? That is, the government would basically be saying “If financial institution A lends money to financial institution B, but then B goes belly up, we’ll reimburse A for the loan.” It seems like that would do a lot more to get them lending than just saying “Here’s a bunch more money for you to hoard.” Plus it has the benefit that if B doesn’t fail, they can pay A back themselves and the government gets to keep their money.
Banks loaning money to each other is a small part of the problem, which has been eased considerably by the bailout funds.
Right now, we want banks to loan to businesses and consumers. I complain a lot about their unwillingness to loan (and I think I’m mostly justified in doing so), but times are bad, and they want to make sure they get paid back. But the gummint can’t guarantee all future loans, because the moral hazard would be too great.
On top of that, banks can no longer easily repackage the loans they make and sell them on the open market to investors. This leads to a drop in overall lending, since the banks can’t get their money back rapidly and loan it back out. More importantly, it also causes the banks to assume the risk of those loans, which is demonstrated by the stronger underwriting guidelines now being used.
You obviously can’t guarantee all loans, or they’ll loan money to anyone regardless of their ability to pay it back, and get free money from the government for all the deadbeats. You could guarantee all loans past a certain credit rating, but how do you decide what that should be? Likely result would either be guaranteeing loans that don’t need it, or guaranteeing foolish loans, in which case giving people free money (stimulus cheque or whatever) is a better choice.
But guaranteeing loans that don’t need it costs you nothing, since the loan gets paid back without your help. Whereas giving people free money definitely costs you something.
But I see your point (and Hellestal’s) that completely eliminating risk would make banks too reckless.
Good loans don’t need a government guarantee, and bad loans should not get one. (Guaranteeing bad loans is one of the ways this crisis started)
The problem is no one knows which loans are good and which ones are bad. Solve that mystery and you solve the financial crisis.
You need to take one step back. The lending freeze didn’t happen out of the blue, it happened because it became impossible to value a lot of the assets the banks held. There were clearly big losses, so banks became afraid that loans made to other banks, as is normal, might be lost. Things that got valued at auctions got hard to value when the auctions no longer happened.
Hellestal, has the inter-bank interest rates gone down a lot? I lost track during the break. If I understand it correctly, that rate is an indicator of the liquidity situation, and if it has gotten a lot better it never made the Times.
I was under the impression that the idea of the bailout was to act as a buyer of last resort for this so-called toxic debt (is that debt whose default rate is uncertain or whose default rate is perceived as too high?). Is that how the bailout is working? I know that the government is buying equity stakes is several institutions, but I am not sure how that helps.