Let Them Die? (Financial Crisis Part IV)

The news of the week is that the bailout failed. And interestingly enough, it seems that the reason the bailout failed was that millions of motivated voters jammed the phone and fax lines of their representatives, demanding that the bailout not be passed. That impresses the hell out of me--maybe the voters just saved us big time.

I'm not an economist, so I'm not entirely clear on what we can do to get out of this mess. To a large degree, I have to defer to the judgment of others. But, as Neptunus Lex so succinctly put it:

Does it occur to anyone else that the only people qualified to really explain to us the consequences of the “credit crisis” - not the politicians who dither, not the newscasters that blather - but the ones who really understand the consequences are 1) the ones who got us here in the first place, and 2) the ones who have the most to gain from our intervention saving their bacon.

Color me a Luddite, but if the same doctors that sent me into toxic shock assured me that only they could fix me, given another $700 billion, I’d be a little skeptical.

Nevertheless, I still can't write my own recovery plan. My instinct, though, is that a controlling principle of any whatever we do must be "the stupid will be punished." Any company that made or bought up these high-risk loans (other than, perhaps, the ones that only did so because of government-arm twisting) deserves everything bad that happens to them. They deserve to fail. Let them die. What I would want from a recovery package would be to protect the companies that are only in the situation they're in because they were forced to.

And at least one guy who knows a few things seems to agree:

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.

H/T: Neptunus Lex