How will the bailout effect businesses in Milwaukee?

October 13th, 2008 by


It really remains to be seen what the actual effects will be, but I am optimistic that things are moving in the right track. Regardless of your political leanings and whether you feel it was “deserved” or not, the bailout was necessary because the flow of money had seized up. You can think of the banking industry, and the flow of money through the economy as an engine, and cash is its fuel.

Lending money is not a zero-sum game, it is not simply a transfer of wealth from one to another, when banks lend money, money is actually created by making those dollars available in multiple places at the same time, here is an example of how the process works:

Business A has $100
Business B has $50

So the total money in the system is $150

Business A deposits its $100 into a bank and gets interest of $5.
Business B is building a new plant for $130, so it borrows $80 and uses its $50 and pays $130 to Business C.
Business B promises to pay back the loan to the bank over 10 years for $100. (The bank made $20)

So, Business A still has its $100 plus $5 interest, Business C has $130, the bank has $15 extra, and Business B has a new plant valued at $130 (of course it spent $150 to get it but it still retains that asset.)

Depending on how you account for it, simply by loaning the money the bank turned $150 into $250-$380. (And realize that this is a cascading effect as Business C now puts its $130 in the bank)

What has happened with the sub-prime mess is that banks are afraid to lend money, the engine has seized up. Thus, there is less money in the system then there should be. With less money, it is harder to invest in your business, make payroll, expand, borrow, and most importantly harder for your customers to purchase goods and services from you (i.e. Business B buying services from Business C).

In theory, the bailout should ease that tension from the banks and allow them to start lending money again, which is good for businesses. The more banks that are loaning money, the cheaper that money will be, the easier it will be to get, and there will be more money available to everyone. Let’s hope that in practice the bailout accomplishes what it intends, and that in their fervor to make those responsible “pay”, legislators have not handcuffed their own bailout bill. Only time will tell.

(Please feel free to comment, especially those businesses, large or small, that have stories about receiving or being denied loans recently.)