I was watching a PBS documentary about the financial crisis with my roommates and the conversation shifted to the notorious bank bailout of 2008.
However, I was surprised because they both agreed that, although the bailout was unfortunate, it was the only way to prevent the national economy from tail-spinning deeper into depression or 'dying' along with the bankrupted megabanks.
Basically, the old 'too big to fail' argument.
However, I am admittedly unknowledgable on this subject and had little to rebute them with other than "if something is too big to fail, it probably should be the first thing that's allowed to fail". Does anyone have any insight to offer me on this topic?
First off, here's a rundown of the situation. I would definitely check out those links if you're interested in more info. But for this particular question:
Are Fannie and Freddie Too Big to Fail ?
Is Bear Stearns Too Big to Fail ?
"too big to fail" --- why is this wrong?
A (Sort of) Debate on Too Big to Fail
Never Too Big to Fail
Too big to fail ?
Fannie, Freddie Failure Would Be World 'Catastrophe'
More Bank Failures
In Defense of Bank Failures
Rot at the Core: KC Fed Pres. Hoenig says " Too Big has Failed", and calls for receivership of failed banks / end to bailouts
Beware the Moral Hazard Trivializers
The War on Recession
What firms are allowed to fail ?
Bring Back the Bank Run!
The Lehman Brothers Plan
Inside Job: A Look at the Heart of the Left
Yet Another GM Bailout
They would go through bankruptcy proceedings and assets would be sold off, creditors would be paid off in accordance with their ranking, and the assets would come under new ownership of whoever buys them. Just like any other bankruptcy.
No worries. It's not an entirely un-complex topic (and that's not an accident).
But yes, Chapter 11 or Chapter 7 are the most common.
You should definitely check out those resources, but the quick answer to your question is, yes, the stock market probably would fall...but if left alone (i.e. not interferred with), and everything went according to the laws that are in place, then it wouldn't be nearly as harmful as otherwise. If the laws are actually followed and the contracts are honored as they are supposed to be—as opposed to violating the bankruptcy laws and bailing out unsecured creditors while stiffing the secured ones—(like what happened in the auto bailout when Obama paid off the unions and left the bond holders high and dry in direct violation of bankruptcy laws), then there is a predictability and confidence in the market. This is the most important aspect of getting out of a downturn situation.
If you go back through past recessions and even this one, the number one thing that is holding businessmen back is a lack of predictability...they have no idea what the government is going to do next...raising taxes, imposing costly mandates and regulations, outlawing types of transactions or ways of doing business...such that making any real business decisions could prove detrimental to the entire enterprise. Thus, business and entreprenuership is retarded, as business people hold off and wait to see what happens.
In regard to the banking system, see the resources here. (In particular, the Federal Reserve section).
Fractional & full reserve banking & the Federal Reserve
Again, I also recommend the links in the opening paragraph here. Overdose in particular might be a good way to get up to speed with a nice overview.
Thanks for the links, I'm trying to devote time to diligently absorb them all--however, one of the central questions that my friends raised I have thus been unable to find is simply, "What would happen in the real world if we didn't bail out the banks?"
Ah, so the proceedings would fall under Chapter 11 Bankruptcy like the Lehman Brothers? Wouldn't a heretofore unseen bankruptcy of that magnitude cause a free fall in the stock market and the greater economy?