The Bright Side of Bank Bailout 3.0

It's an agonizing way to spend taxpayer money, but the end is getting closer

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It’s infuriating. The U.S. Treasury has spent $350 billion to help stabilize some of the world’s biggest banks – and they’re still teetering.

Bank of America, recipient of $25 billion in federal aid it didn’t think it needed three months ago, suddenly requires $20 billion or so more, to finalize the purchase of Merrill Lynch and back a pool of rotten securities. Citigroup, which has gotten $45 billion itself and is 7 percent owned by the U.S. government, is still on such shaky ground that its stock price is slumming it down around $4. That’s an 80 percent plunge from the already depressed levels of last September. When Citi hit $5 last November, Wall Street viewed it as a brief stopover on the way to $0. The only thing that prevented that was a second round of cash from the feds, who also guaranteed about $250 billion worth of unsellable Citi securities.

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That still wasn’t enough. So here we go again. Everybody hates the fact that these huge firms can’t solve their own problems. Yet the government, having come this far, has little choice but to inject more taxpayer dollars into Wall Street’s wounded giants – and assure they don’t bring down other banks.

If there’s any good news, it’s that we’re learning from our mistakes. Here are a few upsides to the third round of bank bailouts since last September:

American taxpayers will get more for their money this time. One of the biggest frustrations with the $350 billion that’s already been spent on bailouts is that the banks have directed barely any of that money back to consumers, in the form of new loans. From a fiduciary perspective, that’s understandable: Bad loans got the banks into this problem in the first place, so lending more money to borrowers who are in even worse shape now isn’t something they’re eager to do. But politics and populism play an important role in these loans, too. And with many members of Congress irate over the use of the money, this time there are likely to be conditions on any banks that get additional money.

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One of them will probably be some kind of requirement that banks work more aggressively with homeowners at risk of defaulting on their mortgages. Before, it was a suggestion. This time, look for it in writing. Bailout out their own borrowers could cost banks money, since many people who receive such “workouts” end up defaulting on the next loan, even if it’s on better terms. But getting the big banks to work directly with threatened mortgage holders may be the best hope for addressing this problem, which afflicts the entire economy right now. Federal workout programs aimed at solving the problem are hopelessly complex and don’t reach people with the riskiest mortgages. Besides, there may be no federal money left for such homeowner aid, since the second $350 billion of bailout money may go into the same black hole as the first $350 billion.

The banks are closer to getting back on their feet. Here’s the progression of the problem: First, it was housing. Those were the losses that creamed the banks in 2008, causing Citi, for instance, to lose billions. With housing prices still falling and foreclosures rising, those losses will continue to plague many banks. But a lot of them have already written off the worst of their housing-related losses, or put aside reserves to cover them. And the worst offenders, like IndyMac, Wachovia and Washington Mutual, have already gone out of business or been taken over by other banks.

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Next will come the usual carnage of a bad recession - rising defaults on car loans, credit cards, and other consumer debt, as more people lose their jobs and fail to pay back their loans. It could still be early days for these kinds of consumer defaults, one reason financial stocks have been plunging all over again; investors are worried about fresh writeoffs the banks may not be prepared for. Nobody is sure when this will all end, and it depends in part on how bad the recession turns out to be. But the problems aren’t endless. With carrot-and-stick attention from the feds, the worst of the writeoffs might begin to subside by this time next year. Yeah – it will be costly.

The bailouts might actually work. Many people are outraged that the $350 billion the government has spent so far hasn’t turned the economy around, or loosened lending standards. To be fair, however, that’s not what it was supposed to do. That money was meant to prevent a financial panic, which was well underway by early October, when Congress approved it. That goal has been met. Credit spreads, a key indicator of faith in the banking system (or lack of it), have narrowed from record highs last fall. Since Lehman Brothers failed in September, there haven’t been any other catastrophic bankruptcies that threatened the overall financial system.

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It would be great if $350 billion could buy outright prosperity, but at least it has bought us a reprieve from doom. Another $350 billion – or twice that, by some estimates – will eventually help restore sanity to the financial system. It’s an agonizing way to spend taxpayer money, like depleting a vacation fund to pay off the damage after you wreck your car. But someday we’ll look back on the bank bailouts as a reasonable solution to a gargantuan problem. Just not tomorrow.

TAGS:
Citigroup
Bank of America
Merrill Lynch
  • Rick Newman

    Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success and the co-author of two other books. Follow him on Twitter or e-mail him at rnewman@usnews.com.

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