All these concerns are correct. The bailouts have probably substantially increased moral hazard, and perversely, arguably undermined the political will for regulation that might reign in that moral hazard. Top investment bankers really do seem to have a worrying about of influence over Treasury and the Fed. The tax burden is large, and should worry you whether you wish that money had been spent on food stamps, or returned to taxpayers.
That said, they were probably the best thing we could have done. If you disagree, you need to sketch out a plausible alternative scenario. Tyler Cowen poses the question for libertarians:
Without the bailouts we would have had many more failed banks, very strong deflationary pressures, a stronger seize-up in credit markets than what we had, and a climate of sheer political and economic panic, leading to greater pressures for bad state interventions than what we now see. Milton Friedman understood all this quite well, which is why argued bailouts would have been a good idea in the 1929-1931 period.
(By the way, some libertarians like to pretend that Milton Friedman blames the Fed for "contracting" the money supply by one-third in that period but in reality Friedman blames the Fed for having let the money supply fall by one-third and not having run a bank bailout.)
If you are a libertarian, is not our current course more favorable for liberty than would have been a repeat of 1929-1931? If not, I would be curious to hear your counterfactual version of how matters would have proceeded, without the financial bailouts. Is it that you think the regional banks would have raised the financing to pick up the entire bag and keep the banking system afloat? Or is it that natural market forces would have somehow avoided a wrenching surprise deflation? Or do you think the authorities for some reason would have not nationalized the major banks? Please let us know.
Maybe you think that the bailouts will have disastrous long-run consequences. And maybe they will, I worry about this too. But if anyone should know that modern politics can only stand so much short-run panic, it is libertarians and fans of Bryan Caplan's book. If we had not done the bailouts we did, we would, within a few months' or weeks' time have received a much worse and costlier bailout run by Congress and Nancy Pelosi. How does that sound?
There are things about the bailouts that could have been done better; I think both Democrats and Republicans demanded too little from the large banks in return for its support. But the basic strategy seems like the best option in a bad situation. On the other hand, maybe this is an argument for liberals that we shouldn't have done the bailout . . .
Don't mistake being opposed to the bailouts as being opposed to any government action. They are not the same thing.
Friedman called for an expansion of the money supply during the Depression, not for the government taking an equity stake - complete with a voice on the board - of private banks and industries. I'm pretty sure there are other ways to expand the money supply than that.
Would some really large banks have failed? Absolutely. Are they "too big to fail?" Absolutely not. There's a reason that these companies got into trouble. Instead of allowing these banks to fail, and taking the bad leadership with them, that bad leadership is now entrenched.
I don't recall Friedman calling for "incompetence rewards."
FDIC was grown to $250,000 per depositor. That helped quell panic. There's nothing that says the government couldn't have protected any number of other non-FDIC instruments to further avoid panic - without socializing banks.
Nationalization would have been the best course.
Applying some of the vast sums spent on the bailouts to saving renegotiated mortgages with the government-operated banks, wiping out damaging consumer debt ( and altering the bank and credit card operations to fix interest rates below a specific usury point), extending unemployment benefits and employee retraining -- these measures would have spent the money on the people, the real valuable resources, rather than on a "financial industry" in need of disassembly and re-assembly in a very different modus operandi.
Bets of all, nationalization would have allowed the government, once consumers were made whole, to select which institutions to allow to fail (most of them) thereby restoring capitalism's fundamental discipline (you fail, you're screwed).
And to re-structure this "industry" without many of the "innovations" (fraudulent, failed schemes) that toppled everyone else's economy.
Many of the high-profile types who caused the disaster would be unemployed, but hey, they're geniuses, no? They'll land on their feet somewhere. That doesn't include those who will be indicted and convicted.
and altering the bank and credit card operations to fix interest rates below a specific usury point),
The credit card companies have done some slimy things like suddenly lowering credit limits and trying to create false charges. It seems like new legislation has prevented that, which I'm thankful for. But if you look at places like Goodwill, who offered a non-profit payday loan, they were offering what most people would consider 'userous' rates, upwards of 400% yearly interest, just to break even. The result is that banning high rates is not going to cut into greedy corporate pig profit margins. It's going to simply ensure that certain people don't get credit cards. And perhaps you support that, but then people start complaining about discrimination and redlining.
Wiping out consumer debt would have had as much moral hazard as wiping out banks. (Perhaps allowing a lower interest rate on such debt in exchange for government enforced payment would have been helpful. But then you have the price of enforcement. )
And to re-structure this "industry" without many of the "innovations" (fraudulent, failed schemes) that toppled everyone else's economy.
What would a 'restructuring' look like? If you mean 'forcing banks to look at tax returns rather than people's promises' that's happened without nationalization. What kind of a 'restructuring' are you hoping for?
I'm not familiar with the Goodwill program, but what I know about payday loans is that they exploit the poor by charging them outrageous rates. Wal-Mart has recently exercised a bit of social leadership by offering a much lower rate to cash checks. I think issuing credit cards to people who can't pay or who would be charged usurious rates is exploitation and should be banned. There has to be a way to help the responsible poor who need access to credit and not issue cards to irresponsible people -- including middle class and above people of all races.
Wiping out damaging consumer debt isn't the same moral hazard because the idea is not to just reset the "trough" to zero and re-start the madness. This means all those people who are "under water" and those who can never pay off the principal -- not every credit card bill in the nation. It transfers the moral "retribution" to those who offered these bad deals, with the help of a compliant Congress.
Restructuring would include:
Reinstating Glass-Steagall or passing something that does essentially the same thing.
Forbid many of the financial "instruments" invented by the fraudsters. If things like credit swaps are permitted, they need to be tightly regulated. Everything needs to be totally transparent, so that investors know exactly what they are buying into, so there's a visible line between lender and borrower.
Pass and enforce a usury law, with a rigid upper limit -- maybe 10 or 15 percent. If companies want to succeed, they need to be lean and efficient. A little Darwinism, please.
A single agency empowered to regulate the "industry" and enforce regulations with prosecutorial power.
Drastically restrict most types of lobbying -- this would apply to all industries, not just finance. For example, absolutely nothing of value given, no campaign contributions, gifts etc. just like other federal employees live with. All communications with legislators stenographically or otherwise recorded and published. Absent this our votes will continue to be nullified, and we live in an oligarchy, not a republic.
The overall objective would be to return finance to the mostly dull and non "innovative" role it formerly performed. Talented people who want to be challenged and make a mark would do better by pursuing career in science, public service or the arts.
I think it's fairly obvious that without Fed intervention, all of the nation's large banks would have failed in domino fashion.
The Fed's loans to AIG prevented the demise of Goldman Sachs (through which was laundered $13 billion in TARP funds.) Had Goldman failed, all other large banks would have also. The Fed also abandoned its definition of solvency since to not do so would have meant having to close all the largest banks. Hundreds of the nation's banks are today insolvent, but are being allowed to remain open so that the Fed can slowly close them over enough time where the media doesn't notice what's really occurring right under their noses.
The Fed really didn't have much of a choice once the chickens came home to roost.
Goldman Sachs was too big to fail - and still is. That's why it should be systematically gutted by its regulators and forced to give up the largest part of its market share. Goldman Sachs is an ongoing systemic risk. Its use of its political power to maintain its virtual monopoly is also a systemic risk.
So too AIG. The systemic risk presented by AIG is that too much of the nation's bank assets were insured this single company. AIG was also not required to set aside proper reserves. AIG is in the process of being broken up. Goldman Sachs should also be broken up, along with Bank of America and Citigroup - so that no large banking institution controls more than 5% of the nation's deposits.
The SEC also should share a huge portion of the blame. It is plain that the Securities and Exchange Commission has been compromised. They were actively protecting some very rich men who were running massive Ponzi schemes. And yet, no organization is investigating the obvious corruption at the SEC.
Investors no longer believe in our capital markets - and they shouldn't. The markets appear fixed and certain entities appear to be able to operate outside the law with protection from government officials - with no repercussions.
The remaining corporate bailouts - of GM, Chrysler, Whirlpool, etc are merely political payoffs to the unions. This is the Democrat Party stealing taxpayer dollars and paying off their political supporters.
What should with think? Reign in?
.
Megan, please, work on English before presenting your usual mixture of libertarian dogma and fact-free assertions.
I generally have to agree with Arnold Kling on this point:
If the US Government does continue to make a profit from the bailouts, as it is doing so far with the major banks (but not Fannie, Freddie, FHA, and AIG), then the argument that it was a liquidity crisis rather than fundamental insolvency becomes more credible, and that would lead me to think that the bailouts were a good idea.
The first bailout, beginning circa 2000, was of the military oil complex which was desperate.
That broke the banks, and now states are going down.
James Madison knew about our greatest enemy long ago.
As Vox Day has been pointing out over in his blog, there have been more bank failures for a higher amount of today's money (post-inflation) in 2008-2009 than occurred in 1929-1930. This is hardly a high success.
We aren't preventing the 1930s, we're replaying them, or worse the Japanese Depression of the 80s. Instead of taking these toxic sludge loans and securieies and throwing them into the landfill, the FDIC is keeping zombie banks alive. BB&T is writing down 40% of Colonial's loans a couple of weeks ago. 40 percent! The FDIC allowed Colonial to stay undead until it exposed us, the taxpayer, to 15 billion dollars of loss.
When the number one regulator, designed to promise the taxpayer and depositor zero losses, deliberately allows multi-billion dollar losses, there is no trust. Like Japan, we are setting ourselves up for either 20 years of slow rot and perma-depression or a massive Treasury crunch (when the Japanese or Chinese quit buying) and a complete meltdown.
This libertarian would rather have sacrificed the banks early, when they still had some value at resale, instead of having to sell them now for a complete loss, like Colonial. Now, we have zombies rotting all over the financial market, and a mess that could take the entire government with it.
We aren't preventing the 1930s, we're replaying them, or worse the Japanese Depression of the 80s.
First of all the 90's were Japans "lost decade" and second I find it hard to fathom how you can say the "Japanese Depression of the 80s" is worse than the 1930s...
These are all good points. Break out the M-16's...
;)
The issue of Zombies is very real, and very disturbing.
Indeed. Corporate zombies are an imminent danger.
That presumes an adequate supply of braaaaiiinnnsss. Under the present circumstances, the zombies might starve to death rather quickly.
The biggest issue I see with the bank bailouts is that our Congress has lost our trust - not this Congress in particular, but Congress over the years. I have no doubt that the bank bailouts, like the stimulus, were loaded with favors to cronies and an interest in changing our economic structure. If I could believe that Congress wanted nothing more than to stabiize the banking system I would have been wholly in support of the bailouts. As it is, well.......
We should remember the reason for the bailouts. The banks held large amounts of assets that were once mistakenly thought to be perfectly safe but were quickly discovered to be wildly insecure. The market for these assets all but ceased to function upon this shock to the system, but while no one could be quite sure how to estimate a "fair" price for these now "toxic" securities, it was clear that there would be huge losses with dramatic impact on the health of the financial system at large. Uncertainty reigned and approached panic.
The key thing is that these losses, whatever their final extent, must be borne by somebody, and the real question is only "Who?" That is - though a severe downturn may be unavoidable, to which entities can we distribute these losses that will result in the least permanent damage and yield the optimal end result for the economy and nation at large.
Because of the scale of the problem, the answer is, unfortunately and unjustly but probably inescapable, the federal government.
But if you come to that conclusion - the question remains "In what manner shall we execute this collectivization of loss?" It seems to have been decided that the manner which preserved as much of the value of the country's financial sector institutions as private ongoing concerns and allowed an eventual "exit strategy" for the federal government from the crisis would be the best solution.
If you come to those two answers, then I would guess the range of options for governmental decision makers is actually quite limited.
"The key thing is that these losses, whatever their final extent, must be borne by somebody."
Not necessarily.
Two other possibilities exist:
1) Losses don't have to be taken. If, for example, I own a stock that suddenly decreases in value, I can hold that stock and not take the loss. I could hold it long enough for the underlying value of the stock to once again be realized by the market. If the stock value increases one day, I may not ever realize a loss.
Banks don't have to sell their mortgage-backed securities. They could hold onto them (realizing income from them) until the market for MBS is re-established once uncertainty can be reduced.
2) Losses don't have to be absorbed by "someone." They could, instead, be absorbed by "everyone."
The Fed is absorbing the losses to the banks by printing dollars. It is now lending those dollars at no costs to banks (0% to .25%). The banks are making money on those loans and shoring up their balance sheets with these profits.
Where are the profits coming from really? These profits are coming from the devaluation of all the other dollars currently in savings - also known as inflation.
This is spot-on. Even though it doesn't "feel" like inflation, because there is so little other demand in the economy, the profits that we are seeing are paper profits. They are 100% manufactured by the printing press, and not by any velocity within the economy.
Nobody "saved" the dollars that the banks are lending.
This is another potential "zombie" trigger. If the banks are doing their fundamental job of converting savings into investments, but have instead become nothing more than outlets for printed money, the future is grim.
Spot on? Are you kidding me?
Losses do have to be taken - it's called mark-to-market and it's the law. But even if M2M was relaxed (which it eventually was), banks have reserve requirements they need to meet - as their assets shrink in value, so to shrinks their ability to make loans. Remember - this is/was first & foremost a credit crisis - without short-term commercial loans, small businesses all over the country go out of business for a lack of being able to make payroll.
As for velocity in the economy, we're now seeing upticks in loans, public offerings, home construction, etc.. Employment and consumer spending (the lagging indicators) are next. When you have panic, mitigating the panic can allow growth to return. This wasn't a down market, it was a frozen market.
The only problem with this is cash flow - it's disappearing. There are 15-20 million underwater first mortgages and many more HELOCs and second-lines behind that. Cure rates for delinquent mortgages have declined from a 2000-2006 average of 45% to a current level of 6.6%. You can paper over insolvency for a long time, but cash flow will always get you.
Mark-to-market isn't the law. The Federal Accounting Standards Board relaxed mark-to-market accounting rules in April - specifically to avoid having to force banks to "take losses."
There's a very good reason for that. If mark-to-market was the law, then all of our banks would be insolvent and have to be closed.
http://online.wsj.com/article/SB123867739560682309.html
Rules are fine things, but if following the rules dictates the collapse of our society, then we are free to change the rules. Thus, mark-to-market accounting rules were changed for now.
"The only problem with this is cash flow ..."
You're right Thomas. Holding onto your "losing" securities until they become winners inhibits you ability to do anything else, because you have no free cash.
That's exactly what happened to cause the "credit crisis." Enter the Fed - which is handing out free cash to everyone.
Voila! No more cash flow problem.
Mark-to-market isn't the law. The Federal Accounting Standards Board relaxed mark-to-market accounting rules in April - specifically to avoid having to force banks to "take losses."
April of 2009, movertyperguy. The credit crunch hit its peak in September of 2008.
Rules are fine things, but if following the rules dictates the collapse of our society, then we are free to change the rules.
FASB rules are binding to financial institutions, just as other regulations are. If they're not followed, there can be legal penalties. And as I said above, even when they were relaxed, other issues still persisted.
Loaning money against assets that are worth significantly less than the balance sheet shows has its own risks, even if the financial statements look OK...
Yes necessarily,
1) The MBS are more like bonds than stocks, they have to pay out regularly. This payout comes from people paying their mortgages. To say that people aren't going default on their mortgages to a degree that causes these AAA MBS to default is to deny the housing bubble.
2) A semantic quibble without a point. I think everyone who reads this site is sophisticated enough to understand that the government can distribute the loss through inflation. The loss is still borne.
Tim,
The bigger problem is that "investors" aren't able to purchase these mortgage backed securities any longer.
When Wall Street talks about "investors" they don't mean you and me. They mean the big pension funds like CalPers, which are legally prohibited from purchasing less than AAA securities. (I've vastly simplified this explanation for purposes that will become evident below).
The real problem with MBAs is that they no longer have AAA ratings; thus the big ass investors can't purchase them. Thus, there isn't a market for them; voila ... their worth falls to near zero.
What's going to be really, really interesting in the next few months is the solution to this problem:
The ratings agencies are going to be tricked into re-valuing these exact same mortgage-backed securities to give them AAA ratings again so that the big ass investors like CalPers can start purchasing them again.
How are they going to do that little trick?
Simple: They're going to re-inflate the housing bubble by re-packaging mortgage backed securities in such a way that there will be pressure on the 3 ratings agencies to give them AAA ratings.
http://www.fresnobee.com/559/story/1612146.html
Repackaging toxic waste into shiny new containers.
And you thought Mr. Burns was just a cartoon character!
True, but the US dollar displaced the gold standard for international currency. So the US has its hands a bit more tied than some countries.
Sometimes I wonder if the gov't's realization that 'deficits don't matter' is tied to the fact that our currency had become the world's reserve. If that changes, what happens regarding our debt?
"If that changes, what happens regarding our debt?"
Simple: We default on it.
ahem - return can be simply wrought by receiving more than one put in, but "risk-adjusted return" means receiving the *appropriate* amount of return for the risk that one assumed (or for the risk that one relieved on behalf of one's counterparty) - let's use the latter method, please, assuming we all have graduated from middle school
when we consider that the scenario was SO dire that the USA Treasury had to corral all the major banks on a Sunday and FORCE them all to accept aid in order to shield/disguise those who *really* needed the aid.............i think it's reasonable to assume that the whole system was at risk, and therefore judging the risk on a per company basis is unsound/incomplete - all the firms were relieved of risk that they all were likely to cease to exist, by a govt that (not unique amongst all/any other govts) required uninterrupted access to capital markets in order to rollover existing debt (all G30 gvots borrow extensively in order to support the various levels of deficit spending extant) - ie. if these had been drycleaning companies there would have been no bailout - there is reflexivity of need involved, in that the banks want to exist and make money, and the govts need the banks in order to facilitate borrowing so that the govts can continue to spend more than they collect in taxes.....there is no "them" and folks should understand that it is all about "us" - and the idea of return is very squishy when you consider that the whole pattern/fabric of modern govts/electorates and economies was(is?) at risk
therefore, everyone singing hosannah's about the great return of govt from their various aid programs for WallStreet is complete bunk, esp since they come from folks who most assuredly are not innumerate or illiterate or new to the concept of risk-adjusted return - in fact, from the above it could be argued that the govt aid programs were in essence for everyone who benefits from the current socio-economic configuration
so it goes
The bank / anti-bank debate has been with us ever since the Hamilton / Jefferson debate, extended to Jackson / Clay. Fact is, Hamilton won the debate. America is a banking and commercial center. Without a gov't backstop, America's bank failure (or nationalization) would have replayed the Kredit-Anstalt Bank failure of 1931.
"I think both Democrats and Republicans demanded too little from the large banks in return for its support"
I appreciate this is just an after thought and not your main point, but it is a point that often confuses me. It's the whole "we should have attached more strings" argument.
It confuses me in two ways. First it seems that it is very hard to accomplish two competeing goals at the same time. The more you try to limit an organization presumably the harder it is for the organization to survive. While their may be great arguments for concessions that you would like to receive from the banks, it seems once you decide that it is your main goal to ensure the survival of these banks (and do this for affordably as possible) the best way to do this is to give them money and stay out of their way. Put on restrictions when you're less dependent on their survival.
Secondly, it seems the argument is encouraging the government to buy influence that they wouldn't otherwise have. But the government can exercise all sorts of influence without paying for it if they didn't restrict themselves. Surely these restrictions were debated when they were imposed. If it was determined that this sort of government influence was a bad idea when it was free what makes it a good idea when it costs money?
Because there was a constant dichotomy of purpose - everyone wanted to stabilize the financial system while punishing the banks. Obviously, you can't do both simultaneously...
banks or other government programs. :)
MM, We the People are ultimately responsible for,
and, as proved by the last 50 years of US history,
incapable of, controlling our government spending;
Politicians cannot tax, spend, and get reelected,
unless a majority of the voters are chanting in unison:
We want it all, we want it all, and we want it now.
Having advanced, step by step, into a position where
our only choices are bad, worse, and don't go there,
we console ourselves on having made the least bad
choice ***and refuse to correct our errors *** by:
1) Breaking up companies which are too big to fail.
2) Reforming our financial system.
3) Auditing the Fed.
So we will end up there; Wait for it, won't be long.
Counterproposal; Since the people can't stop spending
money, and printing more only works for so long, try
creating more of the real wealth the little pieces
of monopoly money are supposed to represent.
Prediction: If we do go there, the people who lead
us back will restructure the government, and they
will not be holding a popular vote on its nature.
"Is it that you think the regional banks would have raised the financing to pick up the entire bag and keep the banking system afloat?"
Yes, along this line. I remember, I was almost the lonely voice arguing that:
- bailouts are fine;
- but those should not go to the same banks (JPM, GS, WF, BAC, C of the world) who brought us into this mess, but to all other regional banks.
That way we would have capable banking system to serve our Economy and at the same time we would have dumped all those who committed blunders without rewarding them.
But alas, Simon Johnson is right in this case. If GS in times of Great Recession can arm twist a bankrupt Uncle Sam still to pay money via AIG; we have no hope in this country to shake the influence of Big Money and Wall Street in this country.
There are two things permanent in this country - our constitution and Wall Street Bankers. No matter what, Wall Street Bankers will always get their way out. The thuggery of existing iBankers would end only when our republic ends (or they bring it down).
Both Bernanke and Obama simply did not have the vision and political gumption to weed out the bad players of Wall Street. If you have to spend money, what would you do? Would you do it on the same ones who created the problems or would you try to prop up many other competent, but new players?
Well, in any case that is water under the bridge. 'Audacity of Hope' also has limits and feet of clay.
I don't have a problem with bailing out bank depositors. I do have a problem with bailing out the bankers themselves.
Whose to say that what the government has done has achieved anything but put off the day of reckoning. The bad debt is still there. Some of it has been moved from private hands to government balance sheets as was done with FNM and FRE but the bad debt and the growing pile of government debt and guarantees hasn't disappeared so debt deflation remains a real risk.
Of course some government backstopping was necessary to prevent runs and panic but the government pledge to not allow any of the gang of 19 to fail achieved that. As to recapitalizing banks my hope was that instead of having the FDIC guarantee their debt bondholders could have been forced to convert their bonds into equity stakes. Why protect some
Saudi prince's or Singaporean SWF investments in Citi and allow a good ole American hedge funds stake in Wamu or GMAC to be wiped out.
An exercise in hindsight is, by definition, pointless, but I would like to raise this point: we never bought up the toxic assets.
Given that these were the core of the problem, I don't understand to this day why Paulson pulled his switcheroo after he got the $700 billion. There was historical precedent for its success (the RTC), the market was clearly valuing MBS assets irrationally (default rates were never going to approach 100%, which is what a frozen market suggests), and cleaning up the balance sheets sounds to me like the quickest way to restore confidence in the markets and allow the banks to start making money for themselves again. Plus, you avoid the whole natioanlization/government-in-your-face trust issue you have now.
Why was this so quickly abandoned? Anybody?
The answer is that there wasn't enough money. $750 billion didn't begin to cover the problem.
The solution is already being worked on. Investment banks are busy repackaging the currently worthless mortgage-backed securities into new tranches.
Ratings agencies will give these securities fresh AAA ratings, so that the largest investors can begin buying them again.
They're refloating the bubble.
What he did was first proposed by the Bank of England after Paulson made his proposal. It looked like a better way to handle the situation; so we went that way.
The problem is that bailouts of this type always seem like they work for a while. In reality, the bad debts are still there, they are just being accumulated on the balance sheets of the central banks the the treasuries around the world. In addition, in an attempt to prop up the asset prices underlying these debts, we are in the process of creating even more bad debt (witness the GSEs today).
The crises are increasing in amplitude. What policy action are we capable of next time? Do we increase government spending to 130% of GDP?
Megan,
Tyler is looking back, not forward, and his time frame does not completely encompass the crisis. You have uncritically adopted this position. This is serious problem.
The problem with moral hazard and debt is that they create problems in the future. The benefits have been received but the costs have not yet been paid.
It is perhaps true (although I am not willing to cede this point ), that at this exact point in time we are better off. But when the costs come due the problems we have sown will bring their bitter harvest.
I would add the additional problem that, if libertarians are challenged to offer a solution, it's not fair to them to pick the starting point least amenable to libertarian solutions.
How about turning back the clock 10 years to when the government set us on this course and asking the libertarians to jump in then?
Viola! No bailouts, just like the libertarians suggest. Because there would be no need for them.
Any other problems you want a libertarian solution to? They're out there, you just have ot refrain from stacking the deck first.
That's a really, really tough thing to prove. Fractional reserve banking systems have panics, whether or not there's government involvement, and the interventions necessary to prevent a fractional reserve system from arising are probably not possible. Experimental asset markets show bubbles arising and popping, and there's very little evidence that the government has anything to do with this. Shareholders in lightly regulated industries do not provide noticeably better oversight than those in banking or utilities. We've had national bank panics--disastrous bank panics--for much longer than we've had significant national bank regulation, much less moral-hazard-inducing bank bailouts.
Maybe you have some other policy in mind that would have stopped the housing bubble from collapsing and taking the banks with it, but I've been listening to libertarians on this for a while, and I haven't heard any very convincing ones.
We've had national bank panics--disastrous bank panics--for much longer than we've had significant national bank regulation, much less moral-hazard-inducing bank bailouts.
In the 19th century, bailouts took the form of state governments allowing banks to suspend payments in specie. This happened many times - 1815-1817, 1819, 1837, 1839, 1857. Post-Civil War there was very significant national banking regulation that had a host of problems of its own.
A failure of a bank to redeem in specie is a violation of its contract with the depositors. This failure should trigger bankruptcy and liquidation with the depositors getting the assets. Instead, the government allowed the banks to violate their contracts and stay in business. This creates moral hazard, and is one of the reason's the wild cat banks stayed in business rather than going extinct and being replaced by more sound banks.
Of course, the real problem with the libertarian argument is that there is simply no recorded instance in history of a government allowing a completely independent, laissez faire banking sector. Given the current state of affairs, I highly doubt that any of us will ever see one. So it probably makes more sense just to think about how to make a quasi-free market banking system be reasonably functional.
BTW, Megan, you should respond to Winterspeak's post about the bailouts: http://www.winterspeak.com/2009/08/looking-back-at-bailouts.html Or even better, do a bloggingheads.tv with him. His writing has made the most sense of almost all the commentary I have read. His current post about the bailouts is spot on.
An additional point regarding Tyler's final paragraph:
If you want to argue that our political system, was incapable of generating a better solution to the banking collapse, that is fine. But that is a different point from arguing that the solution it generated was the best that could have been done.
It is also an argument for trying replacing Nancy Pelosi, with a system that is capable of generating a better solution.
Let me apologize for my grammatical atrocities. :)
My friends stopped by right and called me off to lunch, and I hit post while editing a sentence for clarity. The point should be clear enough, even if the phrasing is awful.
The 1921 recession had a mass deflation and real bank failures. Production and unemployment were restored within one year. Modern economists look at this restoration of production and unemployment as a failure because prices went down.
Yet what is the real economy besides production and employment? Isn't the whole point of economic activity to produce and sell "stuff"?
I imagine someone out there is very confused right now thinking about how they never heard about the 1921 recession. That's because it represents the complete refutation of Keynesian theory, and the saddest part of all, at least in our intellectual culture, if historians collectively decide to ignore an episode it ceases to exist.
Here's my counterfactual- The bubble in the financial services sector would have burst, Goldman & JP might have crashed and we all would have realized that said bubble was formed from the creation of complex bets (made on ordinary investment assets) that ungodly wealthy people were selling each other but had little impact on Whole Foods ability to make payroll.
The Fed funneled hundreds of billions to banks, but then paid interest on, and demanded elevated, reserves so you didn't really get as much anti-deflationary bang that Tyler presumes from the bail-out. The bail-out just preserved some favored constituents who should have liquidated or shrunk, like GM, Goldman, etc. (I'll grant that Fannie and Freddie are more complicated because our Chinese bankers were getting scared.)
(Also, the failing banks, manufacturers and investment houses were ready to sell assets to more prudent money at cut-rate prices before the Government stepped into to stop the market-driven shakeout and punish prudent investors.)
For the metaphysicians of laissez faire, reality is always stacking the deck.
Good lord, that's an abuse of metaphors.
Hmmm. Agreed. It's pretty bad. And it didn't end up anywhere near the intended comment. Lost, lonely, and abused.
As someone who is generally opposed to all sorts of government intervention, the bailout was the right thing to do.
I am also a student of system dynamics. I know the destruction that feedback loops can cause in any system, and their victims are usually the innocent actors in the system.
Also, the Fed let it be "understood" that certain institutions were "too big to fail" through implicit actions over time. Government created the moral hazard through this arrangement, and was then obliged to deal with its consequences.
However, there should be a new policy, stated unequivocally, that "too big to fail" is "too big to exist".
We should not let financial institutions collapse if the risk of systemic meltdown is real. To combat the moral hazard, in the future, we should require that any firm who requires government support must sell significant portions of itself in whole or in pieces within 365 days, or be auctioned off.
The Federal Government becomes creditor in the first position.
Bondholders will be mostly protected, but shareholders will take a massive haircut.
Despite that, they will still have the incentive to maximize the value of their shares over the next 365 days. It will create a strong incentive to avoid looting of the company. All compensation packages to company principals must be approved by a proxy vote.
What will emerge would be a smaller, better capitalized entity. By virtue of their smaller size, they would be less able to pose a systemic risk in the future.
At the same time, you avoid the panic that would ensue as creditors and bondholders fear being wiped out.
Shareholders would have stronger policing powers and incentives.
It would essentially take on the form of a managed break-up of the company.
This allows the winners to swallow the losers, fire their management, and clean up the system.
Citigroup could have been forced to sell off it's profitable businesses, which would have protected them from contagion and raised capital for the ailing part of the company.
It would punish and protect at the same time.