Monday, August 22, 2011

A Bad Idea Can Do Some Real Damage

What we are experiencing now are the fruits of the "too big to fail" mentality. In the US, the crisis of the Fall of 2008 began with the government orchestrating a purchase by JP Morgan of Bear Stearns with a $ 29 billion guarantee by the US government. That was the beginning. Before they were done the politicians had bailed out half the financial system, even those who did not wish to be bailed out.

Now the European politicians are doing the same thing. Greece was too big to fail. Now, Spain and Italy are too big to fail. Germany and France are, no doubt, to big to fail too, but there is no one left big enough to bail them out.

This is all ridiculous. No one is too big to fail. The world would not have come to an end if the various financial institutions that were liquidity starved had been permitted to fail in 2008 (or provided some orderly form of Chapter 11 bankruptcy). There was absolutely no reason to protect bondholders from the risks that they had assumed. They should have suffered not the taxpayer. Ditto today for Greece, Ireland, Italy, Spain, and Portugal and, if it gets that far, Germany and France.

Bondholders take risks too. Why shouldn't they pay the price, if they have taken a foolish risk.

By not letting the chips fall where they may, the Western economies now face austerity programs, zombie institutions, and economic stagnation for generations. Is this price worth paying just to protect a few bondholders?

The problem is that politicians love this. It makes folks like Tim Geithner feel really powerful to wander around distributing taxpayer funds to those in need. But, it is very bad economic policy and we are paying a horrendous price for such bad policy.


Carter Hoerr said...

Ed, enjoying your blog, despite the reminders about the tough situation we're in! Thought about you this morning when I read this:

Alex said...

Hi, I totally agree with you on the multiple bailouts that the governments are performing when the creditors have to assume their credit risk. When I buy an equity share of a very big enterprise that's "too big to fail" and the stock plummets, nobody comes to me with invitations to give me the taxpayers money, so why my taxes have to bail out the bad strategies of some bank clerks. It's certain that the fall of big name as Lehman emits shock waves thorough the financial system, but this is an acute pain that's preferable to the agony of the Greek scenario.

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