Money Where’s the Multiplier Effect in this Bailout?
posted by September 26 at 11:57 AMon
The people who really dislike this bailout are starting to speak out. John Washburn at The Brad Blog thinks Paulson’s plan could allow Paulson to buy Microsoft for a buck? (Thank you to slog tipper, Jeremy.) I’m not entirely convinced.
A financially savvy slog reader made the following point to me in an email:
The point of the bailout was to inject liquidity back in the market, which was supposed to have occurred after people had confidence in their banks again. That’s not going to happen. We do already have a much better method of injecting that liquidity directly though, and I feel dumb for not having thought of it before: the Small Business Administration.
Let’s stick with the $700 billion number. $500 billion in loans for any business with 100 or fewer employees that wants to expand. If you’ve been profitable three out of the past five years, guaranteed approval up to $1 million. $200 billion for startups, normal (meaning 1990s normal) application standards apply.
If we buy bad debt, it means that there’s one step with no multiplier effect. Really, it’ll mean smaller writedowns for the banks, so they may go all conservative and not lend at all, so their books look even better. If we give it directly to the small businesses, it’s got a multiplier immediately, since it’s going into the banks as actual deposits, that then get spent on equipment, buildings, supplies and so on. Cuts out the fat cats altogether, gets liquidity back in the market, indirectly helps the banks, and is guaranteed to create millions of jobs.
It’s a great point. Allow me to attempt to translate this to plainer language:
Let’s say you have an extra four thousand dollars available to you. (How? You’re a Stranger reader, and thus have a completely reliable, irrefutable source of financial advice upon which to draw. We brought down WaMu. We can make you rich!)
You want to help the economy get back on it’s feet. So, you’re going to lend out this money to help one of your friends who is struggling, giving out a no interest loan that can be paid back at leisure.
Two friends come to mind.
One guy took out a home equity loan at the peak of the bubble, and spent the money on a bunch of get-rich-quick schemes—like buying up the original iPhones to flip on ebay. He’s lost about a quarter of what he borrowed when these schemes failed. His original plan was to pay back the loan by selling his house, but then the bubble popped and his house is worth about 20% less. He needs your money to pay back the difference he now owes on his home equity loan.
A gal you know has opened a small but thriving bakery on Broadway. She needs a little cash to buy a new commercial mixer—to keep up with demand. But the banks aren’t lending money to “risky” small businesses anymore. With your four thousand dollars, she could buy the mixer, hire a person to run it each morning and grow her business.
Which is the better choice, for the economy as a whole? Let’s follow the money.
If you give the money to your guy friend, he will indeed pay off his loan. The bank will take his money and, most likely, keep it. The banks are really sweating things now and are hoarding cash. Rather than lending out your guy friend’s money, they’ll probably keep most of it as cash. The impact on the economy stops with the money sitting around in an ATM, waiting to be withdrawn in the next panic.
Give the money to your gal friend, and she’ll go out and spend it on a new mixer, plus start paying a new salary to an employee to work the mixer. Her employee with spend part of her paycheck around town, helping many other businesses. The mixer company can, in turn, spend your money on employee salaries. The employees of the mixer company will probably save some of their salaries, but spend most of it. The places where these employees spend their money will in turn spend the income. This multiplier effect makes your four thousand dollar initial investment have an impact of many thousands of dollars.
Go with the gal and her bakery. The Federal government should do the same.