The government’s case for its bailout of failed financial firms rests on misrepresentations of the facts and the misuse of words that do not stand up to scrutiny.

 

1. There was no liquidity crisis in either sense of the term. The most prominent characteristic of problem liquidity is high interest rates caused by solvent but illiquid debtors rushing for cash. A crisis is by its nature short-lived, lasting hours or a few days, as firms acquire or do not acquire the necessary cash, and survive or fail.

 

2. The Department of the Treasury’s bailout plan is inappropriate to a liquidity problem (even if one had existed). The traditional approach is for the central bank to supply cash at high interest rates to illiquid but solvent firms in order to preserve the payment system without salvaging failed activities. In the current case—at least until the increase of uncertainty because of the government’s possible involvement—the payment system was not at risk. Most banks were operating as usual. And contrary to the fear-mongering of the government, the press, and hopeful beneficiaries on Wall Street, bank loans were rising, including between banks, to business, and to real estate. Mortgages and other loans to sound borrowers have continued to be available at modest interest rates.

 

3. Illiquidity is a market condition that has been twisted to mean the inability of an insolvent firm to borrow. For example, Wachovia claimed it had a liquidity crisis that it could not relieve by borrowing in the capital markets. But solvent banks, which make up the majority in this country, continue to have access to interbank lending.

 

4. The Treasury will have to borrow the $700 billion for the bailout from the already strained capital markets. This could endanger liquidity unless the money is immediately restored.

 

5. The plan is to buy bad investments at above-market prices from insolvent (effectively failed) firms. To what purpose?  What will the failed firms do with this gift, which is a more appropriate name than bailout. There is no reason to believe that, given their decision-making history that the failed firms will invest the government’s money any more prudently than they did that of their private investors.

 

6.  The absence of factual or logical supports leaves the Treasury’s case resting on congressional fear. The panic is in government rather than markets or the public. Despite the overwhelming opposition of many congressmen’s constituents, they endorsed the Treasury’s plan because the secretary of the treasury and the head of the Federal Reserve Bank said world is on the verge of a calamitous event.