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Why the Bailout Makes Sense

By Morgan Housel - Updated Apr 5, 2017 at 8:29PM

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Thanks for listening, Hank.

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.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Citigroup Inc. Stock Quote
Citigroup Inc.
$64.11 (2.54%) $1.59
Bank of America Corporation Stock Quote
Bank of America Corporation
$45.34 (3.42%) $1.50
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$162.48 (2.91%) $4.59
The Goldman Sachs Group, Inc. Stock Quote
The Goldman Sachs Group, Inc.
$387.72 (2.99%) $11.24
Morgan Stanley Stock Quote
Morgan Stanley
$99.39 (4.34%) $4.13
Wells Fargo & Company Stock Quote
Wells Fargo & Company
$49.32 (4.47%) $2.11
The Bank of New York Mellon Corporation Stock Quote
The Bank of New York Mellon Corporation
$56.34 (4.06%) $2.20

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