Column : Bail, but Wall Street not out of jail

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By the time you read this, the US Congress will probably have approved a $700 billion bailout plan for America’s ailing financial system. First things first: is the bailout necessary?

The blunt answer is yes. Financial institutions in the US continue to be weak, and continue to collapse with an eerie regularity. It may not be long before there is a run on a commercial bank, which will deepen the crisis further. In any case, banks are already running on each other—no one is lending to anyone else in the absence of confidence in the other’s solvency—the complete opacity of toxic assets on balance sheets will not inspire confidence any time soon. The wholesale money market has thus dried up, and before long, the real economy—consumers and industry—may be choked for credit. If the real economy begins taking a hit, growth will become negative and unemployment, which is already at recent high of 6.1%, may rise further, confirming a recession and perhaps even a depression if both the financial and real economy go down together. The worst case scenario is, of course, The Great Depression when many banks failed, the real economy collapsed, and unemployment rose to 25% largely because rescue came too late—Andrew Mellon, the Treasury Secretary at the time preferred a “‘liquidate, liquidate, liquidate, until the system is purged of bad debt” strategy and look what happened. The US and world economy would rather not risk emulating that episode in history. Closer in time, there is the example of the Japanese recession through the 1990s on account of its moribund and unreformed banking system, which was belatedly—with a huge cost to the economy as a whole in the 1990s—rescued by the government in 2002.