Bailouts: Getting To The Root Of The Question

2011-10-12

One of my friends asked me a really interesting question last night: did it cost less to bail out the banks than to let them go under and then fulfill FDIC insurance for account holders with those banks? The answer to the question should have been crucial in making a decision on whether to bail out the banks. If the bailouts were not cheaper, then they are very difficult to justify. If they were cheaper, they might be justified. Of course, this whole thing could have been avoided by cracking down on blatantly irresponsible and predatory investment practices rather than encouraging them, and requiring that banks hold a significantly higher cash reserve than the current 10% minimum. And of course, giving banks and investment firms a total of over 100 billion dollars without strings attached could only be described as idiotic were it not intentional. Interestingly, in all the news coverage I've read, I have never seen my friend's question asked or addressed. I could not find the answer via an internet search last night either, although I found some hints. What bothers me is that this questions is central to understanding the problem and the answer should be easy to find. The banks surely have known the answer all along, and the government could have verified this information in a few weeks with an independent audit (perhaps they did and didn't bother to tell us?).

Let's take Bank of America for example. Bank of America claimed to be worth around 600 billion in 2006. This estimate is probably grossly overestimated and based on speculation. In 2008, the time of the bailouts, Bank of America held about 140 billion dollars in account balances. The FDIC requires that banks hold a minimum of 10% this amount (fractional reserve), so Bank of America should have had at least 14 billion in cash ready at hand. They received about 45 billion in bailouts. Thus, the question is: did Bank of America have 81 billion (140-14-45 billion) dollars in additional real assets, or were they a phantom company? I would love to know the answer to this question.