The late comedian Jack Benny made a career of claiming to be a cheapskate. In one joke, a robber accosted him and said: "Your money or your life." Getting no response, the thug repeated his demand. Benny replied, "I'm thinking about it!"
That's the sort of dilemma posed by Henry Paulson and Ben Bernanke in their proposed rescue of financial institutions. They predict dire consequences if they don't get their way. But the consequences of letting them have their way are so awful that the alternative doesn't look so bad.
What they prescribe is for the federal government to buy $700 billion worth of lousy assets from banks and other lenders, exposing taxpayers to a potentially crushing liability. This plan would nationalize the money-losing part of the financial sector, to the benefit of capitalists who have made spectacularly bad decisions—fostering more bad decisions in the future.
It would add to the liabilities of a government that is already living way beyond its means. It would give unprecedented power to a couple of officials who have proved highly fallible in trying to avert this alleged crisis. And it poses the risk of abuse and corruption because the government has no way to gauge the value of what it will buy.
Nor is there any guarantee the plan would work. The cover of the latest issue of Fortune magazine hails the "steely-eyed Treasury chief" under the headline "Paulson to the Rescue." The story appears brilliantly timed—until you realize it is about the earlier rescue of mortgage giants Fannie Mae and Freddie Mac. That was just one of several steps taken by the feds that were supposed to halt the downward spiral. None of them has.
The latest action was justified by the threat that the entire credit system would cease to function. "Last week, our credit markets froze," Paulson told the Senate Banking Committee. "If that situation were to persist, it would threaten all parts of our economy."
George Kaufman, a finance professor at Loyola University Chicago, is skeptical. "The last refuge of a scoundrel regulator," he says, "is to shout 'systemic risk.'" Usually, the alarm is false. He notes that aside from inter-bank lending, the credit markets were functioning tolerably well at the height of the crisis. Rates on 30-year mortgages actually dropped last week.
If banks really need to get rid of this junk paper, they could have unloaded it before now. Merrill Lynch did itself a lot of good by facing reality and taking 22 cents on the dollar. But other companies now have the far more enticing option of selling to the government at a premium.
The point of the plan, after all, is to shore up struggling firms by awarding them more for those assets than they could get anywhere else. As an analysis in The Washington Post put it, "the more effective the plan, the more expensive it will be."
Not only that, the more effective it is, the more damage it will do to the free market system. Saving companies from their bad gambles turns business into a game of "profits for me, losses for you," corroding the incentives that make capitalism so innovative and efficient.
And for what? Bernanke warns of a recession. But economic downturns are not to be avoided at all costs. And one good thing about recessions is that they end, usually in a matter of months. An intervention of this nature, by contrast, would have malignant consequences for decades to come.
A group of 122 economists, including at least two Nobel laureates, signed a letter this week summarizing the danger: "If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted."
Not to mention the risk of giving the executive branch powers that a Russian czar would envy. If this bailout goes through, the term "limited government" will have to be permanently retired.
Paulson and Bernanke say, and probably believe, that their program is for the good of us all. But remember what Thoreau thought of their 19th-century counterparts. "If I knew for a certainty that a man was coming to my house with the conscious design of doing me good," he wrote, "I should run for my life."
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