17 September 2008

Government Bailouts Reinforce Irresponsibility

The recent bailouts of Fannie Mae and Freddie Mac, not to mention AIG, are indicative of a government determined to keep foolish investers from learning the necessary lesson about the risks they took when the bought into these companies. In fact, the bailouts rescue the most foolish of the investors, the ones who didn't get out earlier when it was clear that there were problems.

While it is not new for the U.S. government to use taxpayer money to bailout the creditors of failing companies, it is a trend that needs to stop if we don't want to strengthen the existing moral hazard. No company is too big to let fail and there is no "optimal" moment in the economy to let companies fail.

It is understandable that the government wants to avoid letting big financial institutions fail in the hopes of stemming a trend, in order to bail out foreign investors (especially foreign government investors), and in order to avoid letting the derivitives on the books of some of those institutions establish the new market price by which comparable derivitives on the books of other institutions must be measured. All of these reasons are short-term delays in the inevitable purging of over-extended companies and poor investments. Such interventions serve the political imperitive to postpone the inevitable pain of foolish investments, but may well make it worse and more prolonged in the process by deepening the moral hazard.

The standard response in times of crises of "we need more regulation" doesn't address the more fundamental problem of not letting investors bear the full risk of their investments. No matter how much regulation there is, if investors can count on being bailed out by the government when things get bad, they will make risky decisions assuming that the government will never force them to bear the full risk of their investments. There is only one clean remedy, let poor investments be liquidated automatically by the market.

3 comments :

Patrick Roberts said...

from a historical point of view it's hard to object to the government's mass bailouts since similar debt-producing methods were put into action to bring the U.S. out of the Depression... maybe we've been heading for socialism this entire time

Brian Surkan said...

Habitual abuse, albeit numbingly predictable, should ever remain objectionable. I believe that the jury is still out as to whether the government programs during the Great Depression did more good than harm. At best, I suggest that such policies postponed the crises until attentions were focused on (though not healed by) WWII. At worst, those programs may have done more harm than good, keeping us from recovering as quickly or as thoroughly from the Depression as we might have.

Nick McNulty said...

I agree, the fundamental damage done to our free market by The New Deal planted the seeds of the blatant, unconstitutional behavior of our current government. There is a reason that FDR had to raise the spectre of a packed court to pass that boondoggle in the first place.

Government subsidization of Big Housing created this credit crisis, extricating government from the free markets is the solution. SEC regulation - using exsiting regulations, not the reactionary, capital-killing ones coming soon to a portfolio near you - could have limitted the damage done to the weakened economy, but the vulnerabilities in the economy were not created by a "lack of government regulation". That is a misleading talking point being peddled by big government proponents, most of whom have themselves become millionaires over the past 2 decades using similar - though less brazen - wealth redistribution pyramid schemes. Admittedly, I hear such schemes do look quite attractive up near the top, pity not many of us in the lower tiers of the New America do not get to get on C-SPAN and CNN to debate the merits of the current plan.

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