Cato Institute Warns against Cash Bailouts to Banks

The Cato Institute has just published essays in which the libertarian think-tank warns against central bank bailouts via cash injections whenever there is a temporary financial crisis.

The essays come in the wake of the problematic housing bust and the epidemic of mortgage loan defaults that are costing financial institutions, lenders, banks, and investors who put money into sub-prime loan backed securities billions of dollars altogether.

The bursting of the housing bubble is also making investors on Wall Street and abroad jittery, as the tumbling average price of new homes and defaults are making it more difficult to find equity to borrow against. When consumers cannot readily find sources of borrowing, they grow more conservative in their spending, which in turn hurts business profits and therefore business' value. Falling business value means falling stock prices.

While savvy financial advisors tell their clients that falling stock prices simply mean that stocks are on sale, the typical investor and the institutional investors who have huge stakes leveraged in large companies do not like to see sustained falling stock prices and are likely to engage in profit taking, pushing the value of the market down even further.

With lenders now growing more cautious about lending money, and having less of it to lend, investors also fear a decline in mergers and acquisitions activity, which has been on a record tear in 2007 and inspiring billions of dollars to be invested.

With borrowers defaulting, even though banks and lending firms take possession of homes, they are not very keen on doing this-they want the cash they though they would be getting. When consumers go to their banks to pull out their cash, wanting to spend more of their own money since they can't rely as much on credit under the circumstances, they put the banks in financial strangleholds-for the banks, too, have invested their money, or lent out more than they hold in reserve.