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Friday, September 26, 2008

Where’s the Multiplier Effect in this Bailout?

posted by on September 26 at 11:57 AM

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.

RSS icon Comments


And we'll get delicious pastries.

Posted by keshmeshi | September 26, 2008 12:06 PM

The guy friend should be shot.

Posted by Bellevue Ave | September 26, 2008 12:06 PM

That sounds like a reasonable economic stimulus proposal (a good alternative to the stimulus checks that were sent out, since I'm sure the multiplier effect with lending the money to small businesses would be greater).

But, the folks in Washington are thinking about this as how do we secure our banking system and ensure it doesn't fail. They're probably thinking that if half of our banks fail, the economy is doomed no matter what happens from the ground up...

So, it seems like pairing this type of approach with some kind of insurance on the mortgage-backed securities or government investment in the banks in exchange for a stake (like the AIG deal) would be a good approach.

Posted by Julie in Chicago | September 26, 2008 12:38 PM

According to what I'm looking at the SBA makes about $1 billion dollars worth of loans in a year. Your scale is off.

What you're saying is similar to a thought I've had. As I've been trying to understand this, basically our banks are all shot and this plan is trying to "reboot" our banking system. I wondered, well why not just make new banks?

I think that's infeasible though because of the scale of the problem. You're basically suggesting that our new bank be created by making the SBA a hundred or a thousand times larger. That's not a quick solution and not a long term solution.

I don't think people want to nationalize the banks. They want equity to reduce how much we get fucked but eventually we're supposed to get back out. Blowing up the SBA wouldn't lead to that.

Posted by daniel | September 26, 2008 12:44 PM

But how do these sound investments help out the corporate lobby?

Posted by formerly OR Matt | September 26, 2008 12:53 PM

Simply put, WaMu was victimized by a classic "run on the bank." Customers withdrew $16.7 billion in a 10-day period following the bankruptcy of Lehman Brothers, leaving WaMu "with insufficient liquidity to meet its obligations," its regulators determined.

A longer explanation is WaMu was victimized by mismanagement and misguided bets on exotic (and toxic) instruments such as option adjustable-rate mortgages.

-yahoo: wamu run

Posted by infrequent | September 26, 2008 1:34 PM

Jonathan, you are tarnishing the "science" brand by holding forth on subject areas wehre you know less than nothing.

And yeah, thousands of your newly jobless neighbors will surely thank you for bringing down WaMu. Wait til you see the multiplier effect on that one.

Posted by RonK, Seattle | September 26, 2008 1:48 PM

Very well RonK.

I think that science is more than a bunch of trivia. Science is the notion that ideas are proven (or disproven) by facts.

Obviously by commenting this way, you fashion yourself as some financial genius, with me as knowing "less than nothing."

Educate me. Seriously. Tell me what I wrote that was incorrect on this post. Should be easy, readily easy, to disprove the few meager statements I made here--if I'm the big fool you fashion me to be. Argue with facts, not insults and we'll all be impressed.

If you seriously believe that I brought down WaMu, then you are perhaps too big of an idiot to even put together a rational or empiric argument. I've laid out my case, repeatedly, citing facts, other analysis and even the plain old numbers on what happened with WaMu. Prove. Me. Wrong. Or, fuck off.

Believe me, I'm more than a little concerned what this "sale" of WaMu will mean for the local economy. I'm also more than a little concerned about how expensive and ineffectual the bailout plans seem to be.

But, hey, let's go with your plan of maintaining ignorance and stupidity. The score today? I attempted (successfully, I think) to explain the multiplier effect concept. You ran your big fucking mouth, whining about me. Who did more to help out?

Posted by Jonathan Golob | September 26, 2008 2:12 PM

Jonathan, don't bother. RonK's little more than a troll.

Posted by Cascadian | September 26, 2008 2:32 PM

The bailout is a very very very bad idea.

Posted by Will in Seattle | September 27, 2008 12:15 AM

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