The clearest explanation I’ve found comes from a scene in one of my favorite films, “It’s a Wonderful Life.” If you know the film, you’ll recognize it immediately.
[during the run on the bank] “You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house…right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can. Now what are you going to do? Foreclose on them?…Now wait…now listen…now listen to me. I beg of you not to do this thing. If Potter gets hold of this Building and Loan there’ll never be another decent house built in this town.”
What freaked folks out two weeks ago is that funds (Lehman, AIG) didn’t pay back the money they were loaned. They broke the bank. Banks loan money through the commercial paper market. It’s a system that depends on trust. With that trust lost, banks didn’t want to lend each other money. As a result credit has tightened. It’s now harder for banks to loan each other, businesses and everyone else the money needed to keep the economy going. Essentially, that means a rewrite of the “It’s a Wonderful Life” scene for our time might look like this:
“Starbucks money is in Microsoft’s business. And their money is in your utility company’s, and in Home Depot’s, your local hospital’s, and a hundred others. Why, everyday through the commercial paper market of our financial system they lend each other the money they need to do their business, and then, they pay it back as fast as they can. Now what are you going to do? Foreclose on them?”
If we didn’t bail out Wall Street then in effect we’d be foreclosing on them. If banks don’t lend each other money then they can’t lend businesses or people money. If your local retailer can’t borrow the money it needs to buy what it sells, then it may close, or scale back it’s business and reduce it’s workforce. People who aren’t working buy fewer things. That shrinks the need of the retailer to have as much stock on hand or as many stores in operation. That means more folks are out of work and you get a snowball effect that leads to recession.
Is this bill the best we could have done? Probably not. Is it better than the first bill, yes. And this isn’t something we could take our time with.
Does the bail out fix everything? No. This could happen again. The Potter’s of the financial world are real. There will always be people willing to take risks to make money. That’s why following up the bail out with regulation is a good next step.
At the end of “It’s a Wonderful Life” all the townspeople come forward with gifts of money and put them in a large basket. Together they bail out the Bailey Building and Loan. As Clarence the angel says earlier in the movie, “… you’ve really had a wonderful life. Don’t you see what a mistake it would be to throw it away?”