Wednesday, October 01, 2008

Bailout or optout

I just wanted to drop some thoughts to the web concerning the “bailout”. First I would like to point you to a few posts by some very smart bloggers that are for the idea of the bailout. For example, Daniel Drezner is for the bailout. The Skeptical Optimist is also for the bailout. They state so here in these two posts.

I don't know if the bailout is a good idea or not. The way it was proposed and brought up in its initial form were absolutely horrible. The constant reminders that we have to do it now, only made the situation feel more and more like I was wearing wool underwear and running 6 miles. I just want to expand on the central idea of the bailout that bothers me and provide some basic information if you are having hard time keeping up.

One of the key issues that got us into this mess in the first place, was too much liquidity. The low interest rates of the mid 2000's help set us up for this calamity, in the first place. Easy money, help lead to bad loans, which led to bad investments, etc. So telling me that the government needs to buy investments, that no one else will buy, to make sure that the money keeps flowing, just does not set well. The only problem, is that there is an actual problem that needs to be solved concerning liquidity.

The LIBOR rate is climbing higher and higher. The LIBOR rate is the interest that a bank would charge another bank when the former bank makes a loan to the latter bank. The entire idea that banks would loan money to each other was a brand new idea, to me. It makes sense. If you are full on cash and you cannot find enough customers to loan to, why not loan it out to other banks instead of keeping it yourself. It also makes for an extremely efficient way of moving money around in an economy.

The problem is when banks don't trust each other and they start wanting to keep money for their selves. If LIBOR gets high enough it causes a liquidity crisis. It could lead to certain banks being unable to lend out money or at a worse case bank runs by the general populace.

I personally think that it would take awhile (time scale of weeks) for the liquidity crisis to affect the accounts of an everyday person. No data or anything to back that assertion up, just some basic understanding of process flow and human systems. It sometimes takes time for effects to work their way downstream. I believe that we have more time than we are being told to fix the problem, of course that is just speculation.

To summarize, liquidity helped get us into this mess, now no liquidity is the problem. I just don't know if more liquidity is the answer. I just hope for a solution that fixes the problem long term, not postpones it until after the election. I doubt i get what i want for Christmas.

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