Bailout Remix

Some people thought the bailout was too big. Others thought it was corporate welfare.

No matter what most people are thinking, they should know that the financial bailout Congress passed was an inappropriate, inadequate response, and it needs to be remixed, ASAP.

This whole problem started as a write-down of under-performing debt. When loans don’t perform as expected, banks write down the future value of those loans, which impacts its capital ratio. Its capital ratio is key, because it is this number that determines whether a bank can continue to lend, or if it is forced to sell off loans for cash to buttress its balance sheet.

A bank’s Tier 1 Capital acts as somewhat of a multiplier. Each additional dollar of Tier 1 Capital allows for the creation of roughly 10 dollars in loans. These loans make the economy run smooth, providing capital for projects. On the contrary, when Tier 1 Capital falls by $1, the bank needs to call-in $10 worth of loans or sell those loans off for cash to recapitalize.

Therefore, it would be a much better idea to use any government bailout money to recapitalize the banks. By increasing their Tier 1 capital, each dollar from a potential bailout would equal $10 going into the economy in the form of much-needed loans (liquidity). Essentially, with that form of bailout, you get much more bang for your buck.

Instead, Treasury pushed a government-sponsored buying spree of impaired assets that banks hold. It sounded like a great idea, but because the multiplier effect (of directly recapitalizing the banks) was not employed, this $700B will not do much good. Congress’ action was akin to tackling a storm raging in the sea with a teaspoon. “The global capital markets system has had a heart attack,” said Passport Capital’s John Burbank, “and the policymakers are prescribing exercise and vitamins.” Mr. Burbank thinks an amount as large as $5 trillion will be needed.

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