Harvard economist Jeffrey Miron differs with the conventional wisdom on the recently tubed bailout plan:
The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.
Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.
In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This “moral hazard” generates enormous distortions in an economy’s allocation of its financial resources.
Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.
Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.
The Wall Street Journal begs to differ, telling congressional Republicans that if they didn’t like a compromise bill that could only garner two-thirds support from Nancy Pelosi’s Democratic Party, they’ll really be unhappy with a passed bill that gets 100% of the team on side – enough to pass without any votes from the right.
Some have decided that the current mess proves that conservative and libertarian confidence in the power of markets to make the right choices over time has now been shattered. That’d be plausible if it weren’t for the fact that Fannie Mae, Freddie Mac, and yes, a deliberate government policy to harass banks into providing loans to those who almost certainly couldn’t afford them had so distorted fair market processes.
Yesterday the stock market stamped its feet in outrage at the political class, while credit markets continue to hold out for a better deal, banking on taxpayer money to rescue them from their missteps. A trillion dollars of market capitalization was supposedly lost, but the only ones really losing any money were those having to move at fire sale prices, or those fleeing for the exits.
The markets will eventually correct, because that’s what markets do: Banks have to lend and invest to make a profit, and they will when they are reasonably certain that the downside risk is less than the upside potential. That will come about in one of two ways: A cash injection equivalent to the cost of another Iraq War – on top of the one we’ve already got – that may, or may not solve the problem in the long term, or a shakeout of bad business practices and poor personal decisions.
Mostly this is just infuriating: Wall Street colluded with the political class to take on enormous risk at taxpayer expense, socializing the downside generally while keeping the profits all to themselves. When the whole thing tanked, the same folks come around to those of us busting our butts to pay the mortgage and send the kids to school while trying to salt enough away to stay out of the pet food aisles come the “salad days” – fully knowing that the Social Security Ponzi scheme will by then have played out – and then they have the gall to ask for even more money.