When the Bailout Bill was being debated, there were basically two schools of thought on what needed to be done to save the financial sector. One school argued that there were so many bad assets and such imperfect knowledge of who held them that the markets had frozen out of fear and uncertainty. People were afraid to trade because they felt their information incomplete, and thus were unsure if they were making good decisions. As analogy, imagine a lot of people standing in line for iPods, but a rumor spreads suggesting that much of the store's stock is defective. The folks have the money. But they're unwilling to use it because they're uncertain that the product is sound. This was the argument made by Paulson and Bernanke, and the supposed fix was that the government would purchase the bad assets and that would unfreeze the market. Then there was a second argument, made by a lot of liberal economists (notably Paul Krugman and Jamie Galbraith) who said that the problem was not simply that the markets were frozen but that the banks were undercapitalized. Many of these institutions had an absurdly high ratio of debt-to-dollars. In some cases, the ratio was as high as $33 of debt for every single dollar on hand. This left them extremely vulnerable to a market panic. They owed a lot more than they could possibly pay back at once. And given that we were undoubtedly entering into a period of panic, they were going to need to be directly capitalized. The government was going to have to give them money to cover their debt. Spending a lot of time dithering over which assets to purchase was stupid. Instead, the government should do the simple thing: Give them the money required to survive the rush. But that would mean buying stock, which would mean essentially taking over these companies. Not permanently -- they stock would be sold over time, hopefully at a profit -- but temporarily.
