Isn't all debt bad debt?

@Khuutra

To use an analogy I once used in another thread.

If we consider a bank hostage as the country we live in today. There is one man with a gun, with 6 bullets in it, and 30 people held at gunpoint in the bank. The amount of time held hostage represents the length of the recession, the amount of damage the man with the gun inflicts would represent how deep the recession is.

The argument I have, the man is going to kill 6 people. If you rush him, he will kill 6 people, and if you give him 6 hours in the bank, he will kill 6 people. This is how I see the recession. We need a correction (in this case, to remove debt), and the only way to get out of it, is to remove the debt).

Let's put two scenarios in front of you. First one: 10 minutes into the hostage situation, 27 people are standing in front of a man who just killed 3 people, and still has 3 bullets. What do you think those 27 people will do? They will do nothing. They know three people are going to die, and none of them want to be in that group. All 27 are held in suspense (reducing GDP), because they don't want to be one of the three. If he does not kill another person for 6 hours, they will all sit there for 6 hours.

This is where we are today. No one is safe from losing there jobs, so no one is doing anything that would require keeping it. People are not buying cars, houses, going on vacation, etc...

Now, let's say 10 minutes into the hostage situation, there are 24 people standing in front of a man with just killed 6 people, and had zero bullets left. What do you think those 24 people will do? They will take down the man. It will be over instantly.

This is what we want. If we are going to lose 12 million jobs, we want to lose them as close to instantly as we can. If it takes 3 years to lose them, everyone in the country will be held hostage until it's over. If in one month we lost all these jobs, but every business left started making money again, and every company was secure in there future, the people who still had jobs would still spend money. That's where we need to be.

Now people like Akuma think that what we are doing is going to reduce the number of jobs lost (like talking down the guy with the gun), but the problem is it's can't.

When we spent to get out of debt in the 1930's, while I disagree with it, it worked because we had the money. We used money other people earned (through raising taxes), to redistribute and soften the blow. While ideologically I don't like this idea, it works. Today, we have no way of getting that money, so we borrow it. We are borrowing money to solve a problem where we borrowed to much money.

What this means, is it will be 0% effective (and I feel worse then if we didn't, because we are just digging a bigger hole). We need to remove the debt. And as painful as it is to default on billions of dollars, not doing it now just holds the country hostage, with the same outcome anyway.

The unfortunate thing is that, had the banks been allowed to fail, this debt could have legitimately been converted into AAA financial products ...

If the banks had failed it is likely that this debt would have been auctioned off at 5% to 10% of its current book value and many business men would have taken this debt, unwound it (as much as they could), offered loan modifications to home owners (potentially lowering the principle and the interest rate), and then repackaged them according to their risk level and acutioned them off for 25% to 50% of their current value.

No... There's no problem with contracting debt to purchase things you need, such as a house. Of course you (used to) need to prove that you had the income to pay off the debt later.

This whole mess was brought by too easy access to lending, as well as too high home prices (the bubble), which led lots of people to take on debt they can't pay anymore.

Well all of that seems pretty cut and dry, I guess. So we have to get rid of all of this debt - particularly the stuff that isn't going to be paid off.

So we can either smash banks into thousands of pieces or find a way to actually pay off all of it? One requiring taking a bullet, and the other requiring.... I guess sorcery?

That's a pickle.

No.

When you go to file bankruptcy, the courts look at your books, and adjust what you need to do accordingly.

So lets say you ran a business making taco shells. You make $100 million a year, and your expenses were $95 million a year. So you profited $5 million a year, and employed 1,000 people.

You have been growing at a good rate, and to keep going, you decide that you need to redo your IT department. So, you higher a contractor for 15 million, to come in a redo everything.

So all that's done, and then the market falls out, and you only sell 90 million in sales the next year. Now you have debt you can't afford to pay.

If you file bankruptcy, the courts will look at your business model, and could say "well, you keep 1000 people employed, and have a strong model for success. If you just didn't have this 15 million dollar bill, you could be a strong company", and remove that debt all together.

The IT company is screwed, but they would be screwed anyway, because if you devolved, they weren't getting payed anyway (not much anyway).

Now if you were losing money because your operational costs were to high, the courts would just close you down, sell off your assets, and pay as many of your creditors as posable.

So if Bank of America files bankruptcy, it would be obvious that they know how to run a bank, they just have to much debt they can't pay. BoA would not go out of business, they would be just fine.

The real reason we just gave them a lot of money, is because if you do file Bankruptcy, the courts get to set all kinds of things, like executive pay. Bush and Obama are very much influenced by those with money, so they do what they can to keep those with money... well.. with money.

Or we can do what we're doing now. Covering as many leaks on the boat as possible and hope all goes well. Clearly a much more politically attractive alternative.

I'm sorry you guys, but bankruptcy isn't a magical fairy tale land where every problem is solved. And we were not looking at one or two large firms going bankrupt, we were looking at ten to twenty that could have gone bankrupt. Not to mention bankruptcy for some of these financial institutions would have taken years.

Hell, people at Lehman Brothers are still simply hoping that it will take them less than two years to exit bankruptcy.  Yes, Lehman Brothers is still in bankruptcy and plans to be there until at least 2010.  This article is from January:

http://dealbook.blogs.nytimes.com/2009/01/15/lehman-hopes-for-bankruptcy-exit-within-2-years/

Lehman Hopes For Bankruptcy Exit Within 2 Years

Lehman Brothers said on Wednesday it hoped to exit bankruptcy protection in the next 18 to 24 months, but the judge overseeing the case warned that more international coordination would be necessary to meet that goal.

Like I said, the stock market lost close to 40% of its value after the Lehman Brothers bankruptcy, and it wasn't even that big of a firm in relative terms to some of the other financial institutions which were close to bankruptcy. It would have been a bloodbath on the stock market if other firms would have gone down at the same time.

I like NJ5's analogy about a leaky boat. Well guess what, patching the leaks is a hell of a lot better than just letting the boat sink. And a collapse of the financial sector would have been like dropping several anchors through the boat.

akuma587 did the stock market fall because of Lehman Brothers's absence, or did it fall because it made people realize just how big a hole the economy was in? By the way it wasn't just LB going bankrupt at that time, so don't blame everything on LB:

http://en.wikipedia.org/wiki/Subprime_crisis_impact_timeline#September_2008

By the way, not all of Lehman Brothers went into bankruptcy. The core business got sold to Barclays.

The boat analogy has its limits. We're not all gonna die if a few more big banks fail. We need a financial system, not necessarily the current one. Imagine there's a poorer looking but perfectly working boat next to it.

The bankruptcy of ten to twenty of these financial institutions would have turned that hole into a canyon.  People freak out when banks start failing.  There is a reason why you had a run on the banks during the Great Depression.  When people don't feel like there money is safe, they want it in their hands right now.  When everybody wants their money in their hands right now, banks don't have any money.  Banks really only hold 10-20% in assets of what their liabilities are.  If you would have had a run on the banks, even banks that were perfectly financially sound would have run out of money.

I'm not just making this stuff up.  It already happened once before last century. 

I give credit to Bush and Cheney for having enough sense to do something about it.  TARP was the smartest decision Bush made while he was in office, although I can't say the Bush Administration handled the money as well as they could have.  But they did avert what could have easily rivalled the Great Depression.