In a very familiar parable, Jesus tells the story of two home builders. One built a house on sand, the other on rock. The house on the rock withstood the weather. The one that built on sand did not fare so well: “The rain fell, and the floods came, and the winds blew, and they beat upon that house, and it fell, and great was the fall thereof” (Matthew 7:24-29).
If the parable were retold today, it might include an episode in which treasury officials and members of Congress cobbled together a bailout program for the owner and lender of the house on the sand. No matter how much money they spent, however, the ending would be the same.
When the $700 billion bailout of failing financial firms was being considered, the country was swept up in the debate. The bill, which created the Troubled Assets Relief Program (TARP), passed with thin public support. Washington claimed that the bill was necessary to keep the world from an economic Armageddon. Many people suspected that it amounted to little more than welfare for Wall Street.
Who was right? Consider the dramatic change made to the way the program works since then. The treasury secretary said that the government would no longer purchase toxic assets from failing institutions. It would now start giving the money directly to lenders. In other words, the entire rationale of the bailout changed overnight.
Why the change? The problem with the original idea is that it violated every common-sense rule of business. The government would pay far more than the market would bear and then, no doubt, we would watch as the market price slid to the bottom. Every time a supporter claimed that this was a good deal for taxpayers, you could almost sense the rise in deep skepticism. If you believed them, I’ve got a house built on sand to sell you.
Recent weeks have illustrated just how difficult it is to turn bad assets into good ones, and reverse the direction of downward price pressure. Short of suspending all market trading, it can’t be done. The case of the insurance giant AIG demonstrates the point. In September, the government gave AIG $85 billion. The money vanished and AIG reported more losses. Now it is expanded to $150 billion. That should last a few weeks anyway.
It seems that Paulson and others have learned a valuable lesson here. The house can’t be saved. Instead they are turning to save the lenders, a course of action which seems a bit more viable but no less a path of folly. Washington is now looking carefully at which banks to save and which to let go. This amounts to a process of picking winners and losers. It gives a competitive advantage to those institutions that were marginally worse at assessing risk.
Think about what it means for policy priorities. The lender who made possible the house on the rock does not need a bailout. That which lent money to the builder who built on sand is getting assistance from taxpayers. How does this constitute a just solution?
The pressure to continue buying bad assets, however, is not going away. Today we see demands for direct infusions of cash to auto makers, airlines, ever more insurance companies and mortgage dealers. Next we will see demands for bailouts of even such national essentials as coffee retailers. Where does it all end?
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