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The Wisdom of Bailouts
Thanks goodness we bailed out Bear Stearns back in March if we hadn't we might have lost Fannie Mae and Freddie Mac, Lehman Brothers, Merrill Lynch and who knows what else. Oh wait...
Posted by Alex Tabarrok on September 15, 2008 at 08:58 AM in Economics | Permalink
Comments
But I thought all the economics bloggers said banks were in a different category from the rest of the economy. Thousands of businesses go bankrupt every year, and that's supposed to be a good thing (creative destruction, you know). But banks have to be rescued by the taxpayers to protect the 6-figure pay of their employees, all of whom have educations and therefore are equipped to compete in the global economy.
Posted by: Dirk at Sep 15, 2008 9:16:35 AM
So, things would have been better had we not "bailed out" BS? Got any evidence for that?
Posted by: TO at Sep 15, 2008 9:17:23 AM
Too bad we all couldn't have been so sure of what was going to happen back then. Whats it about the quality of a future, not how accurate it is but which side of the market it is on...?
Posted by: Buck Bobbin at Sep 15, 2008 9:19:17 AM
Funny, but I believe Bernanke's theory, based on his study of the Great Depression, is that an orderly liquidation, even a long one, is better than a panic. And, to be fair, if you look at the equity markets, we haven't had a panic over the past eighteen months. Even the CDS market has been pretty orderly, though the pricing has bordered on irrational at points (in my opinion).
Posted by: y81 at Sep 15, 2008 9:19:44 AM
"So, things would have been better had we not "bailed out" BS? Got any evidence for that?"
....I doubt things would have been better. Because it took years to build up the things that brought down Fannie and Freddie, etc. It's not like a non-bailout would have forced the rest of the sector to shape up to avoid failure. Because we've been just facing fallout for the past year. I don't they could. If they knew they wouldn't be bailed out--and found out in March--they just would have failed instead.
If Bear had failed a couple years ago, and not been bailed out, then maybe the rest of the financial sector would have shaped up, but I think by March it was too late.
Posted by: pants at Sep 15, 2008 9:31:14 AM
Somewhere, yesterday, a child was born who will spend an academic career figuring out what the effects of the last two weeks were and what, in hindsight, should have been done.
Meanwhile, while trying to drain the over-leveraging swamp, we're up to our ass in banking alligators [I wish I could make that saying work with black swans.]
Posted by: ZBicyclist at Sep 15, 2008 9:33:45 AM
It's hilarious. Tyler is hand-wringing over posting and Alex tosses up a sarcastic one-liner.
We haven't had any major terrorist attacks lately. That must be because we invaded Iraq.
Noone, at least in government, is willing to set themselves up with falsifiable predictions. They get to claim victory either way it goes. This is smart, but not too admirable. Private firms, on the other hand, roll the dice and win or lose.
I don't know what Alex's comment was about the housing recession not being too bad, but he's right. This whole thing is such comedy. Who can lose their shirt buying homes? Well, you can if you assume something relatively safe is ultra-safe and then lever up. Who could have predicted that these institutions could have taken a haircut and turned it into a beheading. Of course, the ones who did predict it (not me, btw) were called Cassandras and now they are called Polyannas with reference to the crisis.
Posted by: Andrew at Sep 15, 2008 9:56:38 AM
Three Words: Abolish the Fed!
Posted by: at Sep 15, 2008 10:13:26 AM
Re "things would have been better." Wouldn't the public not being on the hook for Bear Stearns debt be considered better?
Posted by: David at Sep 15, 2008 10:57:06 AM
I coulda sworn I read back then on this blog that "it's too large to fail".
Posted by: Phill at Sep 15, 2008 11:01:36 AM
Bailing out Bear Stearns bought invaluable time. The markets have had six months to digest, ruminate, hedge, get used to the unthinkable becoming the probable, whatever. It seems to have helped: Lehman has gone bust without any bailout and a drop in the S&P 500 (as I write this) of about 1.5%, which is indistinguishable from what passes for normal market volatility these days. If Bear had been allowed to go bust back in March, with March's mindset and unpreparedness, I guarantee the consequences would have far, far more severe.
We can already declare Operation Let Lehman Die Already an unqualified success. Congratulations to Paulson who had the nerve to call the market's bluff.
The next time bomb is AIG though, and that will be a very big problem indeed. Back to work.
Posted by: at Sep 15, 2008 11:06:44 AM
I think the Bear issue was that it was a genuine surprise and that the other firms had 6 months to get their counter party risk and leverage issues squared away.
People were going nuts over this but the dow is down 250 points -- not unusual. No general melt down today.
It is time that the credit default market either gets its act together or fail. Good move letting LEH fail and see if the risk management/hedging/netting on the CDS's works.
All this stuff is essentially untestable. However, I think it makes sense to make sure that the economy doesn't melt down over liquidity issues, and that solvency issues are worked out in an orderly fashion.
The country can certainly handle a recession. However, a meltdown of the financial system isn't the best way to clear out the excesses.
Just my opinion.
The cost of this will be less then "stimulus" tax cut.
Posted by: ziggurat at Sep 15, 2008 12:35:19 PM
I used to think that this was a free-market oriented blog. From reading the comments here it's become obvious that my thinking was wrong.
It think Lew Rockwell sums up this whole mess quite well:
http://www.lewrockwell.com/rockwell/imperative-sound-money.html
Posted by: Rich at Sep 15, 2008 12:42:32 PM
You would think that Ben, being a scholar of the depression, would have realized that government intervention turned what would have been a short recession into an 18 year depression.
Posted by: omega at Sep 15, 2008 1:25:26 PM
Econ 101 Pop quiz
Citing references from your textbook by Mankiw, please explain the justification for:
a. having the taxpayer bail out Bear Stearns
b. Wall Street bail out Merrill Lynch and
c. letting the invisible hand take care of Lehman Brothers
Extra credit if you cite Gary Becker, Dick Thaler or Vernon Smith!
Posted by: heckler at Sep 15, 2008 1:38:36 PM
So, things would have been better had we not "bailed out" BS? Got any evidence for that?
When did the standard for government bailouts become "you can't prove it made things worse"?
Posted by: Blackadder at Sep 15, 2008 2:17:32 PM
I would like to see an economist study how much the stock market is currently being propped up by automatic 401(k) contributions.
Posted by: Mark A. at Sep 15, 2008 2:53:24 PM
On a related note. Both President Bush and Senator McCain have said the fundamentals of the economy are strong.
Would any economists like to chime in, perhaps in another string?
Not being an economist, I find Bush and McCain's statements counterintuitive, given the failure of LB, the bailout of BS, the problems AIG is having, and the purchase of ML. On the other hand, there is much to economics that I find to be counterintuitive.
Posted by: Allan at Sep 15, 2008 2:55:58 PM
What has bush done about this economic crisis?
With Websites like http://www.FAKEPAYCHECKSTUBS.com promoting the fact that if you buy their $50 program you can get any loan you apply for, Is it really any wonder why the banking system is in the turmoil it is in today? I have read that using this "Novelty Paycheck Program" was standard practice by Greedy Loan officers trying to push the loan through so that they can make the 6 percent commission on every real estate transaction! SIC
Posted by: don jonson at Sep 15, 2008 3:43:15 PM
Allan: "this economy is fundamentally strong" or "this economy fundamentally sucks" is the sort of wishy-washy statement that politicians make, not the kind of well-defined, testable claim that any academic economist should try to make.
Obviously, the financial sector is experiencing a big contraction, unemployment is up slightly, GDP growth is down slightly, and median real wages have been unusually stagnant for the last decade.
Equally obviously, the economy continues to function, unemployment is still below postwar historical averages, GDP growth is still growing, and life-expectancy increases have been unusually high for the last decade.
Posted by: David Wright at Sep 15, 2008 3:45:55 PM
a drop in the S&P 500 (as I write this) of about 1.5%
Wouldn't you know it, 11:00 am marked the intraday high (apart from a brief period at the start of trading, see graph [link meaningful for today only]), and the S&P 500 finished down about 4.3%, ending the day at its lowest point. Not a Black Monday, but a pretty bad day nonetheless. We had 3% and 3.5% days in the past two weeks, this topped that.
Posted by: at Sep 15, 2008 4:03:05 PM
Allan: I'm afraid a "fundamental" is anything you choose to point to to make your argument. Someone can totally ignore current financial structure and say hey, we have plenty of eager labor, abundant natural resources, and a capital stock that's not too shabby by world standards. When it's used as a political platitude, I think this is all it means. You could have said the same thing in 1933.
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Let's hope the optimists above are right. During the Bear S crisis, the line was that counterparty risk was so extensive and insidiously widespread that letting them fail was unthinkable. With Lehman, we're hearing about setting up mechanisms to net out positions and unwind in relative calm. Hopefully the difference is that a lot of unwinding took place over the last few months, and not that the Fed will now lend money against anything.
Posted by: Colin Danby at Sep 15, 2008 4:07:03 PM
Here's Senator McCain's statement: (http://thecaucus.blogs.nytimes.com/2008/09/15/obama-mccain-weigh-in-on-wall-st-turmoil/?hp)
“My opponents may disagree, but those fundamentals – the American worker, the innovation, the entrepreneurship, the small business – are the fundamentals of America and I think they are strong,” Mr. McCain said. “But today, are being threatened today – those fundamentals are being threatened today because of the greed by some based in Wall Street and we have got to fix it.”
So yes, if you choose a sufficiently motherhood-and-apple-pie meaning of "fundamentals," they're in great shape. Never better! And less cynically, there's important truth in the four elements that the Senator pulled out -- it's just that the history of the last 150 years shows us that all this is not immediately helpful when the financial system seizes up and liquidity outweighs all else.
I leave it to others to ponder the ironies of the accusation about Wall Street greed.
Posted by: Colin Danby at Sep 15, 2008 4:20:04 PM
In 1980, as Ronald Regan was declaring "it's morning in America", unemployment was 7% and GDP growth was -1%. Purely as a political tactic, it may well be a good idea to sound optimistic in bad times.
Posted by: David Wright at Sep 15, 2008 4:56:30 PM
I'll take a Bernanke Put for $1000 Alex. Oh, make it a daily double!
"I find Bush and McCain's statements counterintuitive, given the failure of LB, the bailout of BS, the problems AIG is having, and the purchase of ML"
My estimation is that these institutions are not the real economy, in fact, quite the opposite. What Bush and McCain are saying is kind of like what would have happened if there actually were WMDs in Iraq. They would have been correct, but despite themselves.
Posted by: Andrew at Sep 15, 2008 5:19:47 PM
