Mendoza School of Business

Step in or leave it alone?

Published: September 30, 2008 / Author: Mendoza College

As Washington tries to figure out a way to respond to the financial crisis on Wall Street, many in Congress keep talking about the potential impact on Main Street.

But what does a bailout mean to ordinary citizens and what are the consequences of doing something as opposed to doing nothing? Two economists provide their views.


The bailout proposal is not perfect but will help get the economy moving by thawing the currently frozen financial system, said Frank Reilly, professor of finance at theUniversity of Notre Dame. ‘People don’t recognize how really terrible it could be if we don’t do something,’ he said. Although some taxpayers are calling for government to let Wall Street sink, such a hands-off approach could throw the United States in a deep recession. Reilly pointed to Japan, which stayed in a recession for almost 10 years when that government let bad assets stay with the banks which, in turn, discouraged those banks from lending.

The purpose of the bailout, Reilly said, is to provide capital to financial institutions to benefit anyone who needs to borrow. This will enable banks to begin lending not only to each other but also to corporations that will use the funds to buy goods and services and to cover payroll. On Main Street, consumers will be able to get a loan for a house, a car or an appliance. ‘If you can’t borrow, our economy stops,’ Reilly said. Although $700 billion is the sum often cited for the bailout, Reilly said the chances of taxpayers having to pay the entire amount is ‘quite small.’ The government would buy and then hold the mortgages for six months to one year, at which time those assets would probably filter back into the economy, possibly at a profit for the taxpayers.

Also, government action could lift the mood of the country, giving confidence to consumers and businesses alike to spend. Getting consumers to open their wallets is important to helping the economy recover since two-thirds of the country’s gross domestic product is consumption.
Still the economy will most likely enter a recession, Reilly said, with some predicting the upswing coming in the fall of 2009 and others not expecting a strengthening until 2010.
Even with a bailout, the shortterm will be painful, Reilly said. Without the bailout, the alternative will be worse.


In the short run, having the government help Wall Street will be good for the economy, said Michael Hicks, director of the Bureau of Business Research at Ball State University. In the long run, the consequences are uncertain.

In fact, Hicks said the taxpayers who advocate the government do nothing has a legitimate argument. The economy is ill but it is not going to die overnight if Congress does not write a check. ‘I think there is a very large appeal to holding our breaths and waiting,’ he said. If the bailout comes, the country could spend several hundred billion dollars and have a modest recession.

If the bailout does not happen, the country would also experience a recession but could come out with stronger companies and a better performing economy. Or the country could enter a ‘fairly significant recession,’ accompanied by low double-digit unemployment, inflation and an excessive number of homes on the market.

Hicks compared the government buying the mortgages to consumers buying a grab bag for $5 at a county fair. The government will open the bag, display the contents and then sell items to private investors.

Possibly the taxpayer could lose money but Hicks believes more likely the government will spend between $100 and $200 billion and possibly make money when the assets are sold. ‘It absolutely pains me to tell you, ‘I don’t know,” Hicks said. ‘Nobody really knows what those assets are worth.’ Still having a significant portion of the U.S. economy owned by the government is worrisome, Hicks said, mainly because the government is a bad manager of the economy.

For the taxpayers, Hicks recommended they focus on their families and the things in their lives they can control. Consumers did not have much control over the market and their investments even before the turmoil on Wall Street. ‘Don’t let this overwhelm your life,’ he said. Tuesday, 9/30/08



Topics: Mendoza