CASE STUDY 5:  "The Bail-Out Debate"

As the debate rages about the $700bn financial bail-out plan, BBC News looks at the arguments for and against the rescue package.  Below you will find a brief overview of the core arguments for and against the bailout plan.
For a good concise overview of the Bush administrations stance on the issue, here is an interview with Secretary of Treasury Henry Paulson:
Treasury Secretary Henry Paulson
Face the Nation, CBS
September 21, 2008
FOR THE DEAL

The basic argument behind the proposed government bailout, is that the financial crisis which financial firms around the world have been embroiled in for over a year now, is now rapidly spreading to main street, and affecting companies and consumers who had nothing to due with the investments which are at the heart of the problem. This side of the argument goes that if things are allowed to continue as they currently are, without some sort of intervention, then the problems which have until recently been confined to the financial institutions which have made these bad investments, will rapidly spread throughout the entire economy. The Bush administration's basic argument is therefore that because this is going to have a large affect on the average person who had nothing to do with the problem, that the government needs to intervene and lesson the blow to the individual taxpayer.

Their argument basically comes down to them feeling that if nothing is done, the cost to the US economy and therefore the average taxpayer will be much larger than the cost of the $700 Billion plan they have put forth. A second point that they seem to want to make sure that the taxpayer understands, is that the $700 billion will be used to purchase assets which the government plans to hold for a period of time and then sell in the open market as confidence hopefully returns as a result of them doing so. With this in mind, the ultimate cost of the plan is not $700 billion, but whatever the government is able to recoup from the sale of those assets, which some are saying could actually return a profit.  This is an outline of the arguments for the plan:
  • Global financial stability : the plan is aimed at bringing calm to an extremely volatile global financial system. The world's richest nations, the Group of Seven (G7) say the package will, "protect the integrity of the international financial system".
  • Investor wellbeing : Investors worldwide need a shot of confidence. As billionaire investor Warren Buffett put it: the plan was "absolutely necessary" to help pull the financial system out of an "economic Pearl Harbor".
  • Global slowdown : All sides agree that we want to avoid recession in the world's biggest economy and the knock-on effect that would have for countries that rely on America for trade.
  • Job security : Safeguarding jobs across the economy and preventing bankruptcies that "threaten American families' financial well-being" according to US Treasury Secretary Henry Paulson.
  • Credit freeze : Keeping funds flowing through the money markets so that financial institutions are happy to lend to each other, to businesses and to consumers is vital for any functioning economy.
  • Toxic profits : The $700bn cost of mopping up banks' toxic debts may seem a high price, but when authorities eventually sell these assets in the future, their value may have risen enough to make a profit.
Below is an interview with a vocal opponent of the bailout plan Peter Schiff, where he lays out this side of the argument:

Peter Schiff
Bloomberg, FNN
September 22, 2008
AGAINST THE DEAL

The basic argument against the bailout, is that the problems we are currently experiencing are a result of bad investments and too much reliance on borrowed money. The fact that the price of the assets at the center of the problem are going down, is the markets way of trying to purge these assets from the system. So the argument here goes that by having the government intervene, you are not letting the market do its job. By not letting the market do its job they argue that we are simply propping up a failed system and turning what would be a painful year or two, into potentially a decade or more of economic stagnation.

The second point that people on this side of the argument give, is that ultimately the government will not increase taxes or reduce government spending in other areas to pay for this bailout. The argument here goes that instead what will happen is the federal reserve will increase the money supply to continue funding the large government deficit that this is helping to create, which will ultimately result in inflation and a devaluation of the US Dollar. Here is an outline of the arguments against the plan:
  • Taxpayer burden : The government plans to buy up mortgage-backed assets at its "maturity" value, which is well above the current market value. If the value of these assets does not recover in the next few years, it will get expensive for taxpayers.
  • Ballooning government debt : The plan would swell the budget deficit, which could fuel inflation, economists warn (Mr Paulson has asked to raise state borrowing to $11.3 trillion, from $10.6 trillion).
  • True cost of the deal or how long is piece of string? Since authorities would have the power to buy almost any asset at any price and sell it at any future date, it is almost impossible to calculate the real cost of this deal.
  • Bankers' big pay : There are worries about controlling the mega-bucks bosses earn at the very banks being bailed out - given the view that it was Wall Street "that got us into this mess in the first place".
  • The phenomenal power of US Treasury Secretary Henry Paulson : The rescue plan is his baby and he will control how the $700bn is spent.
  • Too much exposure: Some congressmen object that they want the government to have the right to take a minority stake in any firm that is being bailed out, which would give the state the right to purchase stock in companies in the future.
  • Governance : The plan is a twice-yearly report - critics insist on greater oversight and reporting.
  • Main Street versus Wall Street : There are calls for this package to be extended to help ordinary Americans who are at risk of losing their homes.
BRIEF ASSIGNMENT 5
Your assignment is to choose which position you take in this debate:  should the market be left to correct itself or is it necessary for the government to intervene and take ownership in banks for the public good?

  • This brief should be 5 paragraphs; a minimum of 2 sentences, no more than 5 sentences per paragraph.

  • All sentence must be complete sentences.

  • The first paragraph of this Brief will be the Introduction.

  • The first sentence of this Brief will be the THESIS. The Thesis is a clear NORMATIVE (subjective) statement of the position the brief will take on the issue using the vocabulary and concepts from economics: 

    • Should the banks be bailed out by the government? Why or why not?

  • The second sentence in the Introduction will be the OUTLINE for the rest of the brief listing the three supporting topics which will be presented to back up the  position supported by the Brief.

  • The next three paragraphs will be Support paragraphs.  Each support paragraph will begin with a Topic sentence, and will include at least one POSITIVE (objective) FACT taken from the online articles or the textbook which backs up the THESIS.

  • For the brief, use facts from the video, online articles, and textbook, page 19; do NOT bring in outside facts.

  • All facts in this Brief MUST be cited.

  • A Brief should NEVER be in first person.

  • A Brief should ALWAYS be IN YOUR OWN WORDS (IYOW); you may NOT cut and paste from the internet or any other source or you will receive a zero and this will be reported to the Honor Council.

  • Your brief should ALWAYS be printed out, not hand-written.

  • Your Brief is due at the beginning of the class on the assigned due date; assignments turned in after class will be penalized one point per day late.