Monday, February 2, 2009

Who Pays?

By now it is painfully obvious that the nation's banks have driven their businesses into insolvency. Fundamentally, the banks bet their businesses on a perpetual rise in housing prices. Their bet was wrong, and now they are not merely illiquid, but insolvent.

It appears to me that the discussion over how to fix this problem omitted the first logical step: Who pays for the mistakes?

The realm of possible solutions really has only three possibilities:
1. The Treasury (and permit me to lump Congressionally-mandated solutions here.)
2. The Federal Reserve (Note that the Fed is not part of the government.)
3. The shareholders/bondholders of the banks.

Who are the actual people behind each of those broad groups?

If the banks' problems are solved by the treasury (and the stimulus package, if it passes): This money is nothing more than a loan guaranteed by future income taxes. Put simply, we are committing the money of the next generations for the errors of this generation.

If the banks' problems are solved by the Federal Reserve: The Fed would necessarily create money out of thin air. Who does this hurt? In short, anybody who was thrifty and who saved dollars in the past years. Those who lived beyond their means are rewarded by paying off debt with dollars that are now easier to come by.

The third group is those who ran the banks, and those who lent money to the banks in the form of bonds. At present, there seems to be little to no discussion about putting the burden squarely on the shoulders of these folks.

In summary, we can either make future generations pay, or we can make savers pay, or we can make those who made poor investments pay.

A future post will discuss more about the ramifications of holding shareholders/bondholders responsible.

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