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Why the Bailout Makes Sense

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You've probably concluded by now that the $700 billion bailout won't solve anything.

Since the plan was first announced, the Dow has shed far more than 2,000 points. Trillions of dollars of wealth has vanished. Credit markets have been a disaster. As if the debate wasn't heated enough, I'm sure the bailout opponents feel they've been vindicated, pointing to the swoon as proof Paulson's plan was a $700 billion blunder that won't solve a darn thing.

Well, yeah
Of course, no one said it would solve anything in the first place. No one said it would create piles of newfound wealth, or that the rivers of our economy would start flowing with delicious chocolate fudge. They said it would prevent the financial crisis from imploding beyond recovery. From that standpoint, it's been a raging success.  

Wait, really?
Look, the day before the bailout was announced, Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) were spiraling into what would have been certain death. Had they failed, the ensuing panic would have made the past few weeks look like a cup of hot tea and a Kenny G. album. As Ben Bernanke put it, "If we don't do this [bailout], we may not have an economy on Monday."

Without intervention after the dominoes set off by Lehman Brothers' collapse, the joys of laissez faire would have sparked one of the most spectacular runs on the bank ever seen. People would stop caring about FDIC insurance and start caring about hoarding money under their mattress. Panic would lead to more panic. Small banks, big banks, strong banks ... it doesn't matter. When the masses pull their money out, banks topple like dominoes. Has it happened before? Yep. They called it the Great Depression.

Take your sides
What makes the debate so complex is that we have to choose between what we see (markets plunging) and what we could have seen without a bailout. When you're forced to judge the outcome of something that has happened against what could have happened, tempers are bound to flare.

Nassim Nicholas Taleb gives a perfect example in his book, The Black Swan:

Assume that a legislator with courage, influence, intellect, vision, and perseverance manages to enact a law that goes into universal effect and employment on September 10, 2001; it imposes the continuously locked bulletproof doors in every cockpit (at high costs to the struggling airlines) -- just in case terrorists decide to use planes to attack the World Trade Center in New York City ... The legislation is not a popular measure among the airline personnel, as it complicates their lives. But it would have certainly prevented 9/11.

The person who imposed locks on cockpit doors gets no statues in public squares, not so much as a quick mention of his contribution in his obituary ... Seeing how superfluous his measure was, and how it squandered resources, the public, with great help from airline pilots, might well boot him out of office.

You can probably see where I'm going with this -- Paulson and Bernanke will likely go down in history much like Taleb's legislator, blamed for wasting money and useless government intervention, without realizing that the two might have just saved our butts.

While it's easy to sit back and say, "Let those financial hooligans fail. It's their problem, not mine," it would very much become your problem if your payroll checks started bouncing after your local bank failed. Or if grocery stores that rely on lines of credit to stock their shelves got shut out. Or if farmers that rely on credit to make it through the year ran out of options. Our economy relies on credit, not just for investments, but also for day-to-day survival.

Of course, nobody enjoys nationalizing our banks. It's terrible. But done properly, we can make sure the two most important factors get taken care of:

  1. Stabilizing the financial system.
  2. Maximizing the odds that taxpayers get paid back in full.

Right now, that's exactly what we're doing
The announcement last week that the Treasury would take direct stakes in, and guarantee the debt of, banks like Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , JPMorgan Chase (NYSE: JPM  ) , Citigroup (NYSE: C  ) , Bank of New York Mellon (NYSE: BK  ) , and a few others is about as big of a step as anyone can take to put an end to the financial panic.

What's more, taking direct stakes with precedence over common shareholders is the most responsible way the government can resolve the crisis while doing everything necessary to ensure that taxpayers get paid back, as the Fool called for last month.

Whether you're for or against the bailout, you should at least be pleased that Paulson has demanded equity stakes in every company that gets a dime of taxpayer money. Do you agree? Chime in via our bailout discussion board, or share your thoughts in the comment section below if you feel so inclined.

For related Foolishness:

What now? The Motley Fool is here to answer your questions about this financial crisis. Send us an email at, and check back at as we answer your questions and cover the latest on the Panic of 2008.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2008, at 4:58 PM, mlaursen wrote:

    Wow, so absolutely no thought given in this article to the long-term economic effects of the trillions of dollars that has been added to the national debt. Nor the moral hazard created. All that matters is the short term, I guess.

  • Report this Comment On October 20, 2008, at 5:02 PM, pmbarrett wrote:

    Methinks you are very premature in your analysis of the bailout. So far nothing has happened, positive or negative. I think any chest thumping or glowing testimonials should wait until it has had time to play out. Maybe next year at this time you can revisit the subject and tell us just how well it has all worked out. You have to remember that it is government that is trying to make this scam work, and my, don't they have an enviable record of success at what they manage!

  • Report this Comment On October 20, 2008, at 5:32 PM, mjtria wrote:

    Please see:

    One of the more interesting points made:

    "At one point last week the Morgan Stanley $10.7bn pay pot for the year to date was greater than the entire stock market value of the business. In effect, staff, on receiving their remuneration, could club together and buy the bank"

    We have been had.

  • Report this Comment On October 20, 2008, at 6:12 PM, bradylarry wrote:

    So... the implied government guarantee of Fannie/Freddie that helped them to make poor investments and still get them financed has now been applied to almost our entire 'private' banking system, and that is a good thing? Commercial paper, unlimited depositor guarantees, equity positions in private banks, cheap loans to failing auto companies - all in the name of liquidity to support consumer's spending beyond their means and to try to sustain the unsustainable. At some point, the bills must come due. See for some consolidated and well thought out references to the opposing view of the bailout.

  • Report this Comment On October 20, 2008, at 6:40 PM, mountain8 wrote:

    Just to be anally retentive, weren't the planes used in 9/11 crashed by the pilots? Ergo the bullet proof doors would have helped them. I really don't know, it's been a while?

  • Report this Comment On October 20, 2008, at 7:58 PM, MyDonkey wrote:

    Yet another bankers' propaganda piece from a pull-string doll that's been programmed to repeat the same line.

    Financiers always had a full understanding of the risks they were taking, but the lure of fantastic profits and the belief that taxpayers would eventually bail them out drove them to orchestrate this entire scam from start to finish (with the aid of gullible and shortsighted consumers).

    So now the corporate-controlled politicians give billions of taxpayer dollars to the bankers so they can party with Hank Paulson and all his Goldman buddies while businesses go under and families lose their homes. After the bankers buy up these businesses and homes for peanuts, they'll consider lending you (the taxpayer) some of the bailout money you gave them, and charge you interest on your own money. How clever!

    The goal of this scheme is to make the rich richer and everyone else poorer. And that's just plain wrong. In acting as the bankers' paperboy, Morgan Housel is not nearly as clever as the bankers, but is just as wrong.

  • Report this Comment On October 20, 2008, at 9:34 PM, redneckdemon wrote:

    Will somebody please make up my mind?

    Better idea: Let's all go work for the goverment! That way, when we pay taxes, we can be sure that we will see some of that money again in the for of our own wages (which are taxed again in a vicious cycle). Plus, shares in banks with toxic assets, instead of just those assets!

    I'm going to go get drunk till my 401(k) comes back. Peace out.

  • Report this Comment On October 20, 2008, at 10:04 PM, keddie1 wrote:

    Like the others I don't believe we are far enough into this to declare it a success. We haven't established if we are truly at the bottom of this thing yet or not. No one knows the amount of Credit Swaps in play, and AIG has come back to the well a second time already.... so.... declaring victory on the opening kick-off... hmmm..

    What really gets to me are two things:

    1. That the perps haven't an ounch of remorse for what they did.... and further they don't believe they did anything wrong.... and even further... that we the tax payers OWE THEM THE BAILOUT....

    2. That the government, and the legislation, seems to agree with this attitude...

    The $500,000, so called limit just changes the deduction limited for employee compensation from $1m down to $500K... and the limit actually penalizes the shareholders and no one else....

    And the Golden Parachute is defined to mean any separation pay in excess of $3 million..... They can still get $3 million....

    As for the "equity" it is undetermined yet at what rate the financial instution will have to pay to redeam the equity....

    At the interest rate.... 5% for five years... that's only 1/4 of what we lent them... and then 9% there after.... so it will take another 10 years .... 15 in all until the interest income pays back an amount equal to the principle...

    I'm sorry... but this has sweetheart deal written all over it.... talk about insider trading....

    Ok.. I get it that our 401Ks, IRAs, and shares of stock may well have been worth only 5% of their value instead of the 60, 50, or 40% that it is worth now... .that institutions would have failed and there would be no chance to EVER recover in the stock market.... I get all that..

    However.... what I REALLY WANT.... is for these swindlers to be PUNISHED.....I want them in Jail.... perhaps certain forms of corporate punishment to be reinstated and used liberally.....and an occasional hanging in public like the wild west....


    On a serious note....a whole other way to have done this bailout thing would have been to invest the 700B in infrastructure..... Roads & Railroads, power grids, windfarms, solar farms, nuclear, drilling, new dams, bridges, research programs..... with the requirement that ALL OF THE MONEY HAS TO BE SPENT RIGHT HERE IN THE USA.....

    Then put some of the sensibility dampers back on the financail system... No more unlimited leveraging... if you can't determine the value of a financial instrument it is declared illegal and the person who wrapped it in a non tranparant way goes to ARMs are gone...... 20% down on a house... and ya... we can do FHA 5% down.... for first time home buyers.... your fist house only.... no more "Non Recourse" loans..... and so forth....

    I suppose "W" will do every thing in his power to spend the whole $700B before he leaves office..... it is his last effort to truly screw up america.... my apologies to hard working repulicans as there are some......

    But you know.... The great depression was caused by an very large blunder on the part of the Administration.... it took a while.... but we came threw it... well.. our grand and great grand parents did.... they made it..... and then fought WWII....


  • Report this Comment On October 20, 2008, at 10:34 PM, vv234 wrote:

    What a naive piece of article! Totally illogical. Worse than a 5th grader's argument. Cannot believe MF let it published here.

  • Report this Comment On October 21, 2008, at 1:08 AM, jetkahuna wrote:

    I am half way through "THE BLACK SWAN" and am quite familiar with that argument. The example the author uses is someone gets an airline regulation passed before 9-11 that requires the cockpits of all airlines be locked while in flight. This would have prevented 9-11 but enraged at least the flight crews. No one would have known what was prevented! The problem with this analogy is that the Black Swan Event...our stock market crash and financial collapse was not an unforseen surprise event as is the classic Black Swan event example. A lot of the unsolicited financial advice I was getting told me to sell stocks and keep the money back in November and December. The signs were all there and ignored by the leadership of our government. In fact while supposedly on guard they betrayed the country for their own personal profit. I personally will not be satisfied until the crooked CEOs and the crooks in Congress (Dodd, Frank, Obama; etc.) are prosecuted and their personal money confiscated to pay back their victims. I know fat chance.

  • Report this Comment On October 21, 2008, at 8:34 AM, 4saturn wrote:

    I have one question and one comment: Can the shareholders of the failing banks sue the boards of directors? If the boards are held accountable, won't they be more vigilant in their oversight?

    What steams me about the bailout is that it grew by $1.5 in 5 days. If it was such a national crisis, why couldn't Congress just act on that and not add any pork? They could just as well have put a gun to our (taxpayers) heads. I think the president needs the line item veto power so our gov't doesn't keep expanding.

  • Report this Comment On October 21, 2008, at 11:35 AM, NorcalSurf wrote:

    What a load of tripe. Nationalize the banks so that farmers and grocery stores stay open?

    Why not nationalize the farms instead, comrade?

    Excellent use of 9/11 to tug at the heartstrings and patriotism. Maybe put up a picture of puppy to go along with it.

  • Report this Comment On October 21, 2008, at 3:11 PM, liberty41 wrote:

    Wow, they sure don't get it. How can you invest when the rules keep changing? What if they freeze the markets next week? You lose everything. (Already being discussed).

    Read this:

    Even a six year old can understand it.

  • Report this Comment On October 21, 2008, at 4:12 PM, ferg6 wrote:

    Comparing this crisis to 9/11 is foolish. Last year I was hearing crash and pop talk. This depression began some time ago - the inside the beltway guys also knew but assumed markets would right themselves and cringe when Brown (UK) speaks about the dangers of 'unfettered capitalism.' Sarkozy wants to convene for Bretton Woods 2.

    Are we strong enough to bend to advice from Europe without whining about how we rescued them in WW2?

  • Report this Comment On October 21, 2008, at 4:20 PM, MCahillane wrote:

    Discretion is the better part of valor. Live to fight another day. Long term consequences will be a blessing, because we get to have them. The anarchy which would have ensued without this would have been unfathomable. Like it or not, we're fortunate to have gotten it done. Wealth has eroded enough that you will see some changes in the US style of living. That is a good thing.

  • Report this Comment On October 21, 2008, at 7:04 PM, tjwrunhiker wrote:

    As a taxpayer, I much prefer a stake in a company than a handful of toxic waste. I'd like to think that I will eventually benefit from 'my' stake in the company. Of course for me to think that everybody's uncle will 'pay me back' as a taxpayer at some point is naive.

    I believe that this action had to be taken and hope that we see positive results down the road. I don't like any more than anyone else that I now am the not so proud owner of a 201k but glad that it's not yet an 01k. I like and want to trust Paulson and Bernanke.

    I further believe as many of you do that heads and bucks should roll. Those who took those toxic mortgages and packaged them into toxic waste and then repackaged them and then repackaged them and then labelled them high quality credit, AAA in many cases, need to spend a little time in rooms with triple A steel bars in them. That and the bonuses for wiping out companies enrages me. My outcry is for accountability at the executive level. Many times over!

  • Report this Comment On October 22, 2008, at 4:13 AM, wolfjh wrote:

    Mortgage Backed Securities are like boxes of chocolates.

    Criminals on Wall Street stole a few chocolates from the boxes and replaced them with dung.

    Their criminal buddies at Standard & Poor rated these boxes AAA Investment Grade chocolates.

    These boxes were then sold all over the world to investors.

    Eventually somebody bites into some dung and discovers the crime.

    Suddenly nobody trusts American chocolates anymore worldwide.

    Hank Paulson now wants the American taxpayers to buy up and hold all these boxes of dung-infested chocolates for $700 billion dollars until the market for dung returns to normal.

    Meanwhile, Hank's buddies, the Wall Street criminals who stole all the good chocolates and replaced them with dung are not being investigated, arrested, indicted, nor held accountable.

  • Report this Comment On October 22, 2008, at 8:53 AM, Tiingall wrote:

    Great to see people are beginning to get past the initial emotional impact created by the financial consequences of the scam the banks pulled, and are starting to think about how to punish the perpetrators. That should send a message to anyone else who gets tempted in future. Remmber, the full devestating human consequences of this greed are yet to be fullly felt, That will happen when people start loosing jobs, houses, cars, families etc as the country - and of course the banks - try to recover what's been lost.

    The OECD recently released figures that showed teh gap between rich and poor in DEVELOPED countries is getting bigger. What the bankers and financies have pulled off is helping create that division and they'll continue to generate more scams to satisfy their greed at the expense of everyone else.

    These parasites have no conscience, no business ethics, no compassion, no guilt. If they felt guilt they'd have all resigned and given back the money they stole. The evidence is they have no intention of accepting responsibility for the chaos and suffering caused, and yet to be endured.

    These people who betrayed the trust given to them have to be taken out of the system before confidence in the nation's financial institutions can be restored, and to protect the system from their further criminal activities.

    Look at what the Thai's have recently achieved. They got one Prime Minister scared enought about how long he might spend in prison for corruption that he left the country. The trial found him guilty and now they are trying for extradition to get him back for more charges and more prison time. Meantime they stopped the replacement PM - from the same family controlled party - taking office by sitting in the roads around his office block. They got him tossed out of the PM job they prevented him from doing with another court action over corruption. The Deputy PM resigned because the police roughed up some of the protesters.

    When are you publishing lists of the names of these financial criminals and the addresses of their homes and offices. They have all your details and will use it to fleece you when you fail to pay back the scam mortages they sold you. Strike first.

    Who controls the phone sytem switches, registrations, internet accounts, and all other communication systems they need to run their deceitful activities - other people they have ripped off. Switch them off.

    Who pumps the petrol into thir cars - other people they ripped off. Don't give them any petrol. They are quite happy for you to have insufficient money to puy petrol to get to work or the shops

    Who teaches their kids at school - more people they ripped off. Refuse them entry to the school; same consequences they are very happy to push on your kids by stealing your money.

    Who are the security guards in the buildings where they work - other people they ripped off. Cancel their identites and access rights so they can't get into the building or their offices or PCs.

    Who are the computer people working in the credit card and bank account management sections - more people they ripped off. Cancel their cards and block access to their accounts till the FBI have time to seize the funds. These parasites would do it to you if you owed them money.

    Sit in their roads, block their building entrances, deny their private jets takeoff approval, don't repair their cars, and make sure the media gets their faces onto the evening news.

    Get people power working. Show these criminals who actually has the power, who knows how to make the systems they depend upon work; or not work.

    Stop sitting on your butts complaining and get into action. They'll just keep ripping you off again and again if you don't send them a very clear and toxic message. The OECD figures will get worse.

    Just like a school yard bully, they need a very hard punch right on the nose to make them stop. Do it!

  • Report this Comment On October 27, 2008, at 10:27 AM, froggy112 wrote:

    I like that post above mine..we need to do something about the abuse of power in this country..soon.

    The very first bank PMC? used our money to buy National city..the intended purpose of the bailout was for the banks to loan money not to use it to eliminate compitition.

    like the artical pointed out the emergency started when GS stocks where falling big many million shares of GS does Paulson own?

    what about paulson investments A wallstreet company? can a goverment official own a company that directly benifits from the officails position in goverment?

    we realy should try to repeal TARP..Second ammendment has been used before to repeal bills that do not provide for the presidents ability to discharge someone because they are not part of Goverment. three out of five on the oversight commitee fits that discription. Fed, SEC and HUD

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