Economist Dean Baker, writing today in TARP Martyrs: The Post Mourns Politicians Who Lost for Helping the Banks, contends that the late-2008 TARP Wall Street bank bailout was not necessary.

First, he addresses risks to the commercial paper market,

The most immediate threat to the system, which Fed Chairman Ben Bernanke and others highlighted, was the risk that the commerical paper (CP) would shut down. They claimed that even healthy corporations were unable to borrow in the CP market. Since most large corporations depend on the CP market to finance their payroll and other ongoing expenses, the loss of this market would quickly cause the economy to grind to a halt.

. . . The Fed had the power to single-handedly support the CP market. In fact, the weekend after Congress approved the TARP Ben Bernanke announced the creation of a special lending facility to support the commerical paper market. So, that part of the financial Armageddon story was just a fairy tale for children, reporters and columnists, and members of Congress.

Then he addresses the threat of the giant banks collapsing,

Suppose the TARP money had not started flowing and we saw the chain of bank collapses continue. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, would surely have been killed absent TARP and other special assistance from the Fed. It is all but certain that Citigroup and Bank of America would have gone belly up as well, along with many other large financial instutitions.

Would this have led to financial Armageddon? Well, it surely would have created considerable disorder in the financial markets and led to a few million lawsuits, but the Fed and FDIC no doubt would have taken over these institutions to keep the system of payments operating. The Fed had a contingency plan to take over the money center banks in the 80s when they were threatened by large amounts of bad debt in Latin America. It is inconceivable that it did not have a similar plan in place following the collapse of Bears Stearns in March.

This means that “financial Armageddon” would have meant the demise of Goldman Sachs, Morgan Stanley and most of the other Wall Street titans, but probably would not have led to a qualitatively worse economic situation for the rest of us than what we actually saw.

In fact, he says, letting the giant Wall Street banks collapse would have ended the high-risk, credit-default-swap casino culture, and the culture of multi-million-dollar bonuses.

Baker also points out the huge cost to society of bailing out the banks while letting smaller businesses and regular people fall into bankruptcy. The government could have instead used that TARP funds to extend the credit that the bailed-out banks are not currently extending. Small and medium-sized businesses are in trouble across the country, and the government used up its political capital on the bailouts and the insufficient stimulus.

President Obama’s 2009 stimulus was an attempt to help Main Street instead of Wall Street, but was watered down by political ideology and a belief that they could “attract” conservative votes by removing many necessary elements of the package and wasting a third of it on tax cuts that leave nothing behind. As the economy begins to falter with the winding down of the stimulus, and the banks still not extending credit, it is becoming clear that the rushed TARP bailout was a mistake.

A new round of economic measures is clearly necessary. But by bailing out those at the top on extremely short notice the Bush administration used up the governments political ability to step in and, in a considered way, address the real problems underlying the economic mess. By watering down the stimulus and reinforcing a conservative narrative that “spending is the problem” the administration has undercut its own ability to step in with new measures.