Bank bailout excessively costly because healthy banks also receiving taxpayer gifts

Capitalism calls for equity owners of insolvent banks to be wiped out, bond holders to suffer losses, and executives who sank their banks to be fired. So it’s bad enough the Treasury and Federal Reserve are spending trillions of taxpayer dollars to bail out insolvent banks.

But the Geithner plan’s mechanism for rescuing banks is excessively costly to taxpayers and ridiculously generous to financial firms:

Now, Paul Krugman notes that the Geithner plan for bailing out insolvent banks does so by substantially overpaying for all toxic assets… even toxic assets held by healthy banks. This indiscriminate approach costs taxpayers much more — and benefits Wall Street much more — than a direct bailout of insolvent banks would have.

The question isn’t whether “the banks” are insolvent; most surely aren’t. Instead, some banks are probably insolvent…

And that, in a broad sense, is what’s wrong with TARPish rescue schemes. They try to fix the banks by driving up the price of a whole asset class. Most of those assets are NOT held by the probably insolvent banks. So it’s a diffuse, inefficient way of tackling the problem — a taxpayer subsidy to basically anyone holding toxic waste legacy assets, rather than a direct infusion of funds where needed. Contrast it with what the FDIC does when it moves in: it doesn’t shower money on banks in general, hoping that this will solve the problem; it seizes banks that are in trouble, and recapitalizes them.

Posted by James on Thursday, April 02, 2009