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If the government didn't bailout the banks, who would have taken on the bad loans?

This weekend I got in to a discussion with a very liberal friend who is starting to swing my way on some issues. He supported the bank bailouts because he believes without them most banks would have failed. I told him that that is how the free market works. Where I got stuck was when he said then who take on all the bad load? The remaining banks were too few and too small to handle it. I am not an expert in that field, can someone explain it?



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The capital structure

The first people to take a hit would be the stock/shareholders... the owners of the bank... the stock would've dropped to zero.

If the value of the loans was still lower, then the bank's creditors would take a haircut... X cents on the dollar.

If there wasn't enough money, then you'd eat into depositors and depositors would lose money.

PeterSchiffSays.COM

To

To rephrase what pinish wrote, the loans would have been liquidated at pennies on the dollar. The buyers would be the prudent savers who didn't risk/gamble and can now step in to get assets cheap. These are the prudent investors.
The equity shareholders and many of the bondholders who wrote that risky debt would be mostly wiped out. No need to shed a tear for them, as the gambled of their own free will and took big salary/bonus along the way.

Instead, gov't prohibited this cleansing.process by taking our tax dollars to to prop up the failing system. The big cheese in the financial markets get to take huge salary/bonus for a few more years while the gov't tries to inflate away the costs of the bailout programs.

I really don't understand your question?

When you say who would take the bad loans, do you mean who would suffer the loss, or do you mean that when the bank went into insolvency and ceased to operate who would collect what could be collected on the defaulted loan on behalf of the creditors of the bank?

If you mean who would take the loss, the bank itself would which is why it would likely become insolvent and be taken over by regulators. The liquidator, regulator or some trustee would take possession of the loans and do what could be done to collect whatever could be collected or sell them to some other financial institution at a discount, and then turn those proceeds over to the bank's creditors.

"Bend over and grab your ankles" should be etched in stone at the entrance to every government building and every government office.

Here is a good article on

Here is a good article on how Citi could have been re-organized as a good bank/bad bank, rather than bailed out.

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The bad loans

are still there. The Federal Reserve bank now has them on their balance sheets in exchange for freshly printed money. Tell him the same guys who produced all of the bad loans are still in business and the Federal Government is preventing him from the opportunity to purchase these properties at fair market value. These loans will be dealt with at a later date
through a private/public financed auction that he will not be able to attend.

okay, I'm starting to

okay, I starting to understand this a little better. Many people were not able to pay their loans and therefore many banks failed. If the bailouts never occured, many banks would have gone bankrupt and the loans would have been sold to other banks. Why would another bank buy up defaulted loans for pennies on the dollar? Who would eventually pay off the loan? What happens if the remaining banks did not have enough money to buy up all the loans (what happens if no one wants to buy up the bad loan)? <--In the case of a bad mortgage loan, who receives the property if the bank fails?
Thanks for all your input!

potentially nobody buys it. it's a loss

potentially nobody buys it. it's a loss.

let's say the smiths owe the bank 250k on a house they couldn't afford

then the smiths get foreclosed upon for non-payment.

the bank re-sell the house at say 120k, and takes a loss for the rest. they may sell their debt to other debt collectors/banks. but, suppose, the smiths don't pay them, anyway, or they move out of the country or whatever, then nobody will ever see that 250k.

multiply that to a larger degree and you see why the banks needed to go insolvent (or at least the insurance companies that backed the banks, needed to go insolvent, or both.)

the other banks that survive are the ones who did not over-speculate the real-estate bubble, had correct balance sheets, and had the foresight not to rest their entire existence on faulty insurance companies. Capitalism will keep the good banks in business and it will be a great lesson to the future banks.

the sooner we get all this illiquid debt out of the system, the sooner our economy gets working again.

so it's a actually a good thing -- just not to the banks.

The bad loans may not be

The bad loans may not be sold off at all. They usually remain the property of the bad bank. The proceeds from them (or from foreclosure) would go first to the bank's creditors (including FDIC), then bond holders, then preferred stockholders, then common stockholders. Stockholders usually get nada. If the loans are never paid off, they are never paid off. Whoever was foolish enough to buy stock in the bank or lend it money for bonds are simply out of luck.

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"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

This is a perfect example of

This is a perfect example of why banks should ONLY LEND WHAT THEY HAVE!!!

When a bank lends credit (which it is not allowed to do, but does all the time cause no one questions it) it is lending something that it doesnt have. When a bank lends money, which is all it is allowed to lend, then there can be no problem. 1) the bank is going to make sure the person is good for it, no more 120% 0 down no documentation loans, 2) they can only lend so much.

http://www.dailypaul.com/node/114342#comment-1243786

When

When banks make loans to business (say auto dealers - they pay floor plan charges on each auto on their lot) If the car company went bankrupt, the bank would get pennies on the dollar in bankruptcy court. Same with banks making bad mortgage loans:
1. The bank knew better & did it anyway
2. The bank forecloses on the loan and if the homeowner filed bankruptcy, the bank gets pennies on the dollar
3. If the banks had too many bad loans, it shows the bank has poor business experience and they would file bankruptcy. Those they sold those "toxic" assets to would get pennies on the dollar.

Would you buy anything "toxic"? What does that say about your intelligence verses the bank's intelligence?

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My Take Is;

The largest investment banks would have failed.{ declared bankruptcy }
Bankruptcy takes years to sort out in the courts.
The failed banks might have their remaining assets sold off.

I think the reason the Fed is so secretive is because many international banks had bought bad American loans and if the international banks lost too much they might have sued the Fed or the U.S. banks that sold them the bad loans causing a bank run of epic size in the U.S.

But even if the large investment banks had failed, other banks would have survived to continue the banking in the USA.

The Fed seems intent on covering their tracks, probably because of illegal actions.

beesting

Bank bankruptcies are

Bank bankruptcies are usually handled in a pre-arranged "good bank, bad bank" restructure, so all that the bankruptcy court has to do is sign off on it.

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"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

The remaining banks would

The remaining banks would have been perfectly capable of handling all the bad debts in the system. It wouldn't be much different than how other failed businesses are closed down. All they would do is simply auction off all the assets of the banks to the highest bidders.

...

the bad loans become

the bad loans become worthless or another bank takes them by buying them out for pennies on the dollar.

A prudent man foresees the difficulties ahead and prepares for them; the simpleton goes blindly on and suffers the consequences. Proverbs 22:3
Matthew 10:34 Think not that I am come to
send peace on earth: I came not to send peace,
but a sword.

A prudent man foresees the difficulties ahead and prepares for them; the simpleton goes blindly on and suffers the consequences. Proverbs 22:3
Matthew 10:34 Think not that I am come to
send peace on earth: I came not to send peace,
but a sword.

Good bank, bad bank

The performing loans and other good assets are auctioned off, with proceeds going to the bad bank. The non-performing loans stay in the bad bank. The bad bank is taken over by its creditors and deposit insurers (FDIC). The good assets can either be pieced out, or auctioned off as a new going concern, called the 'good bank.'

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"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln