The hidden consequences of hidden bank mega-bailouts

While the public is outraged by the $700 billion TARP, the real mega-bailout for failed megabanks is the tens of trillions the Fed has handed the banks, mostly invisibly.

While I’ve ranted before on this blog about the injustice of giving failed banks — and, implicitly, their bondholders and stockholders — mountains of free cash (plus the immense moral hazard problem it creates by incenting too-big-to-fail financial firms to continue making “heads-we-win, tails-taxpayers-lose” gambles with their implicit taxpayer guarantee), I hadn’t connected the dots on one of the implications of this backdoor bailout:

Banks are refusing to refinance millions of mortgages, and Christopher Fountain writes, “Why would a bank want to loan money on an asset that no longer offers security [i.e., a house whose outstanding mortgage balance exceeds the house’s value] when it can borrow money from the Fed at 0% and buy government bonds paying 4.5%, risk free?”

The Bush-Obama “give-the-megabanks-however-many-trillion-dollars-they-say-they-need” policy is so horrible we’d actually be better off just handing failed banks a trillion dollars in cash! By letting them borrow tens of trillions interest-free and “invest” it in government bonds, we’ve largely destroyed their incentive to lend to businesses and homeowners. This policy helps Wall Street but hurts everyone else. Giving banks a trillion dollars would be both more honest and far better for Main Street.

Of course, they should have just let the negative equity banks fail, as I’ve argued all along.

Posted by James on Tuesday, December 15, 2009