Still, this plan will require significant resources from the federal government – and yes, probably more than we’ve already set aside. But while the cost of action will be great, I can assure you that the cost of inaction will be far greater, for it could result in an economy that sputters along for not months or years, but perhaps a decade. That would be worse for our deficit, worse for business, worse for you, and worse for the next generation. And I refuse to let that happen.
I think the sentence highlighted in bold is very misleading, and the unquestioned adherence it is getting in policy discussions is very disturbing.<!--break--> If major banks are solvent, then the cost of inaction is zero, while the cost of this bailout is the transfer of wealth that it makes to the uninsured creditors and equity holders of these financial institutions. So let's stipulate that they are insolvent.
Inaction could be interpreted in two ways: the regulators do their job and liquidate them or the regulators don't do their job and allow them to siphon money away from the insured depositors toward the uninsured creditors and the equity holders (while contributing nothing to productive economic activity). I am willing to agree that the second interpretation is costly, but I think Obama's statement that this is more costly than bailout in lieu of bankruptcy is uninformed speculation.
More importantly, if the regulators would simply do their job, then the costs of further inaction are zero. By "further," I mean recognizing that the FDIC may already be on the hook to cover insured deposits in excess of assets. Losses can be capped at their current level, and fewer assets will be tied up in a bank that cannot lend. To do anything else is to throw good money after bad. Any dollar spent propping up a distressed financial institution would have more impact on lending if it were instead spent by augmenting the balance sheet of a bank unencumbered by toxic assets.