One of the things that crept up in reddit as it went downhill was a propensity for "doom! gloom!" headlines. There's certainly a lot to worry about with the current crisis, but let's be careful.
So, investment banks might fail, but as long as people don't pull money out of their checking or savings account I don't think the system is losing money. What I expect is happening is a lot of "fake" wealth is being destroyed but I don't think it's a good idea to buy up fake wealth with cash the government is borrowing. Because, as soon as we borrow money people will take money out of the system to buy our bonds which necessitates our buying assets to compensate.
This is a common fallacy. Bankers manage risk in lending, reducing overall risk. This is valuable, i.e. it creates wealth.
If any given Bankers were not performing risk-reduction service for society, they would be outcompeted in the market by their competitors. Therefore, to say that bankers do not create wealth, would be to imply that bankers are in conspiracy to distort the lending market.
It seems that the institutions did not manage risk. In a very generic view, bankers may have value. But as far as this financial crisis goes, they failed miserably.
I don't think they were doing their jobs well. The same goes for insurers.
One reason the insurance industry is so poorly run is that tax incentives are given to businesses to offer generic health-insurance to their employees. Discrimination according to individual cases is needed, and that is not what has been happening. And when they do individually discriminate (both lenders and insurers), they (being conservative, incompetent, scientifically-illiterate, etc.) ignore well-established important factors such as IQ and the various personality factors -- factors that are known to be determinative of social outcome, and more predictive than past-performance (credit-ratings, etc.).
If they are unable to do their jobs any better than that, then the market should be allowed to have its way with them, just as it did the dozens of second-rate silicon-valley VC firms -- and their, in-turn, poorly-discriminating limited-partners -- that created the internet bubble. Why? Because it makes way for the more-competent.
[Edit: Anamax just pointed out that there was government "encoruagement" in these lending decisions, and that other institutions then took on these poor-risk loans. I think the general principals apply: 1. where the government distorts the market, it causes problems; 2. wherever there is freedom in market decisions, whomever finds himself holding the bag has no-one but himself to blame.]
The other organizations expected to make money buying these loan packages knowing what was in them, so it's hard to see why bankers are to blame.
It may also be a fair statement that the institutions did not know the value of what they were buying because of the way they were packaged. I thought that was one of the obstacles facing the bailout--how to value some/most/all of the troubled financial instruments involved. This lack of clarity seems to add to the risk.
> It may also be a fair statement that the institutions did not know the value of what they were buying because of the way they were packaged.
Are you suggesting that banks lied or that the buyers assumed that the risk was acceptable? If the latter, why shouldn't they take the loss? After all, they were willing to take the gain.
The bailout is occurring under different assumptions - we're insisting on looking under the hood more.
It seems as if they hid the risk, and may even have increased it, along these lines: http://unqualified-reservations.blogspot.com/2008/01/straigh...
Note that some of the slicing and dicing was intended to turn a pile of mortgages into two financial instruments, one with less risk than the original pile and the other with more risk. The two instruments would then sell for different prices.
And, are the buyers actually the financial illiterates that the "buyers didn't know" argument requires? I wouldn't call Merrill Lynch naive about money.
The result of this is there is no incentive to avoid failing big if you where going to fail anyway. Bank's can insure a trillion in assets and their only risk is the bank's assets. Each banker is only risking their job it's not their money (unless they have personally invested in the bank). Over time the banking system acts like a game of chicken where they each banker might as well take ever increasing risks, because they make more money in the short term by taking more risks and the downside is limited.