This article has been out for a while but I believe this Professor Jeffrey A. Miron from Harvard explains well what would have happened if there wasn’t a bailout in the banking system. Disclaimer: since this was written the bailout has changed a lot and some of this doesn’t apply, but the point I want you to take from this is the idea of the government buying the bank’s assets. He is talking about the government buying up the bad assets. Here it is from CNN:
“If banks were fundamentally sound but temporarily in need of cash, they could sell stock on their own to private investors. Few investors now want bank stock, however, because they cannot tell which banks are merely illiquid — short of cash for new loans because their assets are temporarily sellable only at fire-sale prices — and which are fundamentally insolvent — short of cash and holding assets whose fundamental values are less than the bank’s liabilities.
This lack of transparency is a crucial impediment to new investment, and therefore to new lending.
Government injection of cash, however, does little to improve transparency. A bank with complicated, depreciated assets is in much the same position after the government gives it cash as it was before, since outside investors will still have limited information about the solvency of any individual bank.
Perhaps the new cash will spur the sale of bad assets, or nudge banks to reveal their balance sheets, but that is far from obvious. Banks, moreover, might remain cautious even with this increased liquidity simply because of uncertainty about the economy. Thus it is hard to know whether cash injections will actually spur bank lending.
In any event, government ownership of banks has frightening long-term implications, whether or not it alleviates the credit crunch.
Government ownership means that political forces will determine who wins and who loses in the banking sector. The government, for example, will push banks to aid borrowers with poor credit histories, to subsidize politically connected industries, and to lend in the districts of powerful members of Congress. All of this is horrible for economic efficiency.
Government pressure will be difficult for banks to resist, since the government can both threaten to withdraw its ownership stake or promise further injections whenever it wants to modify bank behavior. Banks will respond by accommodating government objectives in exchange for continued financial support. This is crony capitalism, pure and simple. iReport.com: What do you think about the bailout?
Government ownership of banks will not be a temporary expedient. Politicians can swear they will unwind the government’s position once “economic conditions improve,” but no one can enforce this promise. The temptation to use banks as a political tool will be permanent, not temporary, so government ownership will continue for decades, or forever.”
This is a scary future for our country. The rest is here.