Economics

The Case Against the Bailout

Why the government shouldn't save businesses from their bad choices

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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."

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

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  1. 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.

    Yes. As I understand it, that’s exactly where the “Great Depression” came from (and why “Black Tuesday” was so short-lived in the US). Anybody want to expand on that?

    I can not stress enough that government accepting financial risk is not acceptable. I don’t care whether it’s a business enterprise or not — and even the anti-corporatists, those who seem to disfavor voluntary associations, should be able to see that this should apply to both companies and individuals. We’re all getting railroaded.

  2. Another pretty good article from Chapman. Maybe he got the message.

    Not to mention the risk of giving the executive branch powers that a Russian czar would envy

    This is so out of character for this administration. Really.

  3. Are you sure Chapman didn’t put his name on someone else’s column?

  4. If banks really need to get rid of this junk paper, they could have unloaded it before now.

    But, but, but, nobody, I mean NOBODY could have forseen this unprecedented crisis. This is the first time an economic bubble has burst. Ever! This once in a millenium panic was just as unforseeable as a hurricane inundating New Orleans.

    Vote Republican, the fiscally responsible, smaller government, free market party..

  5. As a frequent Chapman critic, I have to join the chorus and ask, “What did he add to his wheaties before writing this one?”

  6. This is so out of character for this administration. Really.

    Vote Republican, the fiscally responsible, smaller government, free market party.

    Epi,
    Want to have a sarcasm contest?

  7. As a frequent Chapman critic, I have to join the chorus and ask, “What did he add to his wheaties before writing this one?”

    Everbody take note. Constructive cricism, e.g. Chapman, you suck, is beneficial.

  8. Sarcasm contest? Let me try:

    Hey, this administration always thinks through its policies…

  9. Want to have a sarcasm contest?

    I so hate sarcasm. Really.

  10. Bush’s speech last night left me with an eerie deja vu feeling; it was like his pre-ware runup to Iraq.

    Just trust him and his henchmen.

    Once bitten, twice shy.

  11. I thought Bush had been pushing for this for a long time in speech after speech… now it’s that the administration is unprepared? I rather think doing nothing would have been the preferable tact, and they didn’t do nothing.

    Get your complaints straight. Congress in the 90s created this problem by legislating unprofitable loans, since government is the entity best positioned to manage risk of course, then this one plans to reverse (read: compound) the problem with $A_VERY_LARGE_NUMBER (“We just wanted to choose a really large number.”).

    Sort of lik how they regulated the railroads to bankruptcy, then found when Herr Wilson nationalized them that they really were in as bad shape as they had claimed. The companies gladly accepted nationalization for the main purpose of increasing rates to break-even levels, something they couldn’t do legally before.

  12. I have a question.

    Why should i be responsible, work hard, and save money at all?

    My government seems to be indicating to me that I need only marginal income to get the credit I need. Then, when I borrow more than I can cover I can just appeal to my gov’ment and everything will be alright sweetie.

    I feel rankled and upset that the consumer-whore basically has his or her hand held all the way through whatever they want while the frugal saver is frustrated and dismayed.

    I guess I wish I liked buying stuff more than I like saving. I’ll have my lobotomy now, thank you.

  13. Why should i be responsible, work hard, and save money at all?

    so you can buy guns! and brussel sprouts. (don’t overcook them)

  14. I used to be a Republican. Things like this bailout (read: socialist grab for power) are why I became a Libertarian. This thing scares me.

  15. Not to mention the risk of giving the executive branch powers that a Russian czar would envy

    I suspect the Dem Congress will look at this, then look at the polls giving Obama a lead, then look at the few remaining months until Obama presumably takes over, and say “Hell, yeah! Executive branch powers that a Russian czar would envy for Team Blue! And a $700 billion slush fund administered by Team Blue! Woot!”

    I predict passage tomorrow.

  16. Phalkor, tou could personally secede. Then it wouldn’t be your government, and you would be working for youself alone.

  17. I’m scared to be alone.

  18. Then hold my hand and we’ll be alone together.

    Just no gay stuff.

  19. this stuff sucks..glad that the dominant opinion on reason seems to be against this. I have said many mean things to all of you, calling you socialist etc. Please, when Rex-84 goes into effect know that I was just trying to raise awareness that criminals are running the government…actual unremorseful, sick, deliberate killer. They don’t care about cosmotarians any more than they like paleos.

  20. The goal of a smaller government has always been a long-term goal. I’m a libertarian Democrat precisely because I want to develop a realistic plan to reduce the size of government over time. One hopeful note is how many people in my party and on the left are resisting this bailout, often for libertarian sounding reasons ( check out the Daily Kos ). This is a hellish situation for us right now, but we can’t give up. Let’s all hang in there, and work for a more libertarian society in our own way.

  21. Don,

    Where were you when the government was being used by community organizers to force investors into unprofitable business decisions for the benefit of underprivileged urbanites?

  22. Don,
    See R C Dean’s post. Look at the statements put out by Democratic pols on the bailout. Now, tell me that you know for certain that this could never possibly have happened if Democrats had been in control of government these last eight years.

  23. Don the libertarian Democrat | September 25, 2008, 11:24am | #
    The goal of a smaller government has always been a long-term goal. I’m a libertarian Democrat precisely because I want to develop a realistic plan to reduce the size of government over time. One hopeful note is how many people in my party and on the left are resisting this bailout, often for libertarian sounding reasons ( check out the Daily Kos ). This is a hellish situation for us right now, but we can’t give up. Let’s all hang in there, and work for a more libertarian society in our own way.

    What party are you watching? The Democrats have largely been in favor of it. Not surprising given that it’s party line that the government can solve any problem. The Republican party, however, has largely revolted against it, as have its supporters. A small ray of hope in the a party that is so very off track.

  24. The Republican party, however, has largely revolted against it

    Republicans don’t revolt. They goose-step. Just like fascists, who weren’t socialist at all. Revolution is for Party members, the compassionate critical thinkers. Didn’t you get the memo?

    You know, they say that only moose and communists could be afraid of Palin, but I don’t know. As a Life-Long Republican, I can tell you she’s just… creepy.

  25. I can not stress enough that government accepting financial risk is not acceptable. I don’t care whether it’s a business enterprise or not — and even the anti-corporatists, those who seem to disfavor voluntary associations, should be able to see that this should apply to both companies and individuals. We’re all getting railroaded.

    Well said. True, liquidation will hurt SOME, it will cause the Recession to last a bit longer, but this bailout will hurt EVERYONE, by fleecing us, taking our savings, inflating the currency (and lowering our purchasing power), rising the cost of living and making the Recession become a Depression, by not allowing the bad assets to liquidate in the market at the price the market WILL accept. It will be a tragedy, and all so that a few of Bernanke’s and Paulson’s friends do not lose their shirts?

  26. The Bail-Out is supposed to help financial institutions with bad mortgages. Many of the non-performing mortgages are A.R.M.s that have reset to higher payments as interest rates have gone up.

    A big factor in determining interest rates is the imputed interest determined when Treasury Bills are auctioned. If the Federal Government tries to auction hundreds of billions of dollars, it will undoubtedly drive up interest rates, make more A.R.M.s unpayable, push more people into default, and further damage the financial institutions at risk.

  27. Spot on. No one can estimate the consequences. It reminds me of the rush into Iraq. (Or of the sleazy car salesman telling you that if you don’t act right now the deal will be gone.) One thing is for sure, it will fundamentally alter the American economy for decades to come.

    http://www.youtube.com/watch?v=CyfIoxTDD6Q

  28. bilco5: “No one can estimate the consequences.” Exactly, but remember that no one can estimate the consequences NOT doing the bailout, either.

    The people who have the real life responsibility for dealing with the situation have to consider risks of both options. They are accountable to the electorate for their actions, unlike the Libertarians who can’t get a dog catcher elected and can sit on the sidelines and snipe.

  29. While it is true that no one can estimate the consequences, good ol’ Rudy Guliani is willing to help the good ol’ boys get their piece of the action, whatever that may end up meaning: Here’s his law firm’s news release regarding their establishment of a “task force” to “guide financial institutions, private investment funds, institutional investors and other market participants through the legislative, regulatory and enforcement challenges posed by the Troubled Asset Relief Act and other impending actions by Congress, the Treasury Department, the Federal Reserve and the SEC.”

  30. 1) Why is is seemingly impossible for so many to admit even the possibility that the market might get stuck in a bad equilibrium, from which it can not extricate itself except over a long period of time and with great cost? These are not physical processes that we’re dealing with, who’s effects can be predicted with certainty and to many decimal places. Yet, the strength of dogmatic negative opinion toward the Paulson plan would suggest otherwise.

    2) It is not possible to know that this plan will be inflationary, let alone dramatically inflationary. Yet, a huge number of know-nothings continually parrot this non-argument. It could be inflationary, but if perceived by investors as a good thing, it could well not generate any inflationary expectations (which are the important thing). And, as I see today on the front of Barron’s, it could well generate positive profits.

    3) It would be interesting to know how many with strong negative opinions have any experience with capital markets at all. I’m guessing the number of such folks is so close to zero as to be hard to tell the difference. This whole problem is about capital markets grinding just about to a halt. Yet, so many with strong opinions (even many economists) couldn’t tell a CDS contract from an OAS or TED spread if they’re lives depended on it. Perhaps that explains why those who actually look at this stuff are so terribly concerned.

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