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19 Dec 2008 12:24 pm

Another Bank Bailout?

Manzi sums up where we are at:

The bailout appears likely to have helped stave off the immediate emergency we faced less than three months ago. It is very unclear how relatively fragile the credit situation is today versus September and October. While interest rate spreads have declined, it may be that Treasury knows of or suspects specific hidden weaknesses like credit default swaps that might put us right back to four-alarm-fire mode any moment.

The endless stream of huge bailout requests has come on more quickly than I expected, and appears to be contributing significantly to the momentum behind incredible spending plans, especially stimulus plans, by the new administration. The equity injection approach that has been used to date runs the risk of avoiding the necessary restructuring and financial pain that will be required to get the financial sector healthy again; and there is at least anecdotal evidence that we may be developing exactly such a zombie bank problem right now. In sum, the bailout so far has been painful, expensive and sloppy, but we’re still in one piece.

Congress has the right to approve or deny any request that Treasury might make for the second tranche of the additional $350 billion. This should be treated as a separate request. We have the luxury of time, as compared to a few months ago, to vet this request with far greater rigor, and in light of what we have learned. Specifically, before authorizing this money, Congress should perform its oversight function, and demand to know: (1) what underlying risks, not to shareholders or employees, but of systemic financial collapse now exist or are latent that would justify this much money, and (2) how we will avoid the zombie bank problem, including potential application of lending requirements in return for capital, as has been done in the UK.

I supported the original bank bailout, and continue to believe that it was a painful, but correct, decision. However, supporting the next tranche will require a lot of convincing.

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