Thursday, September 25, 2008 5 comments ++[ CLICK TO COMMENT ]++

Why Bailouts Are Contrary To Free Markets

Bailing out failed institutions or those that would fail anyway is generally considered to be anti-free-market. Since all the true free market proponents have been separated from the fake ones--the fakers being ones that subscribe to what I call the Wall Street Journal form of capitalism--you don't hear too many arguments illustrating why they are against the free market.

Well, the problem with free bailouts is that it rewards the failed institutions, their workers, their shareholders, and their bondholders. Want to see it in real time?

Consider the argument from John Allison of BB&T Corporation, a bank:

U.S. Treasury Secretary Henry Paulson's proposed $700 billion bank rescue aims to help ``poorly run'' companies and the primary beneficiaries would be Goldman Sachs Group Inc. and Morgan Stanley, said BB&T Corp. Chief Executive Officer John Allison in a critique of the plan.

Treasury ``is totally dominated by Wall Street investment bankers'' and ``cannot be relied on to objectively assess'' the impact of government policy on the financial industry, Allison wrote in a Sept. 23 letter to Congress.

Here we have BB&T bank, which seems to have cleared completely of subprime mortgages and seems to be managed successfully. Yet, such a bank will derive zero benefit from the bailout and would actually face competition from the failed risk-takers on Wall Street and elsewhere if the bailout makes them whole. If you wanted hundread banks in your country would you not want them to be more like BB&T?

Is this not what crony capitalism is? The fake free-market proponents--the WSJ free marketers--have a habit of criticizing crony capitalism in poor, developing, countries and never seem to understand how it manifests itself. I am not against the bailout but there should be a penalty--a contingent equity stake--if purchased mortgages turn out to be toxic. Otherwise, this is no free market at all. We are going to end up with a hundread banks that will eat the wealth of the country. I would rather have a thousand executives like John Allison--all else being equal--than almost anyone that is running a financial firm that will profit from this bailout.


5 Response to Why Bailouts Are Contrary To Free Markets

September 26, 2008 at 4:50 PM

In the final analysis the "free market" is itself a creation of the government as a free market requires property rights and those can exist only when a strong stable government upholds them.

People get way to worked up about ideological purity and "moral rectitude" rather then recognising markets for what they are, practical tools for disseminating information and creating incentives quicker and more efficient then any known alternative, not more and not less.

Sometimes the free market fails, sometimes badly like now, and then the government must step in and stabilise things. That changes nothing about the fact that free markets are most of the time very effective in their informing/incentivising role and for that reason much preferable to the alternatives.

A bailout contrary to free markets? Hardly, instead it is a necessity to correct a system that has gotten into a vicious circle.

September 26, 2008 at 4:54 PM

And would it be good to have only virtuous banks like BB&T? Sure, but humans being the way they are that'll never work. Markets will move to excess going up as well as going down.

Meanwhile I am sure BB&T shareholders appreciate the lack of dilution, the steady dividends and the chance to gain market share while competitors are otherwise occupied. Having a well-run bank really is it's own reward in the long run.

September 27, 2008 at 5:23 AM

In a previous thread you wondered if I support doling out cash to institutions that messed up. I would if it were necessary, which I think it isn't and it isn't proposed anyway. Here is the deal. there are two possible sets of priorities:

1. fix the credit mess ASAP before the real economy starts taking severe damage and Great Depression mk II becomes reality;

2. punish Wall street execs, "faux value investors" and "amateur investors, and of course "evil furriners"

If priority 1 is chosen a bailout plan will have to be very generous so all banks will participate and the dodgy assets that has everybody so fearfull can be dumped quickly to wind down over time. That inevitably means that some people who profited from te boomtimes and may even have contributed to the mess are bailed out.

If priority 2 is chosen there will be no bailout or one with very punishing conditions. Only despereate banks will use it, and probably when it is already too late. Bank execs will try to make it on their own rather then voluntarily subject hemselves and their shareholders to all the punishment the government has in store. The inevitable side effect is that mistrust and fear remain and the financial system continues to lurch from one disaster to the next while credit disappears and the real economy sinks rapidly.

I choose option 1. This mess needs fixing. fast. Or I will have to start shopping for real estate in an remote easily defended location.

September 27, 2008 at 5:39 AM

I have been somewhat sanguine on the consequences of the credit mess, soo you may wonder why I am so insistent a quick generous bailout is needed.

Well, it turns out I was wrong on the consequences of the credit mess remaining limited.

As late as june I figured Europe and Asia would probably make it through with litte damage.That isn't happening. Over here the economy is in a tailspin and Asia is slowing quickly.

Interbank lending is completely gone and so is the commercial paper market. Central banks are flooding the world with liquidity but there is only so much they can do. They certainly have no mandate to lend to non-bank copanies, and those cannot get short-term funding anymore with bank lending and commercial paper both dead.

Lehman is proving to be a second "New York Bank of the United States" (a bank that collapsed in 1930 spreading panic and triggering a run on the dollar). The run on the "Bank of East Asia" this week has everything to do with the fear caused by the Lehman collapse. That collpase was widely publicised there and depositors and investors are very nervous.

We can now follow the advise of secretary of the treasury Andrew Mellon to "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate" (he is being eerily channeled by the houde republicans and the peanut gallery at Calculated Risk) or we can try to stop the avalanche.

And remember what happened when the avalanche was not stopped. By 1936 most of Europe and Latin America had fallen under the control of fascist oriented governments, Spain was in civil war, Japan was seeking to conquer it's way out and Germany was governed by the Nazis.

This time round economies and individuals rely on banking and credit far more then back then. The Mellonists have no idea what they are calling for.

September 27, 2008 at 6:30 PM

Good stuff ContrarianDutch... you should be writing your blog :) I'll try to respond to this or maybe write a post about if I can gather my thoughts...

Just to quickly say something, I'm not against any bailout per se. I'm a liberal in that I don't mind government intervening in the markets (for instance, without govt intervention, SEC wouldn't exist and we would get the wild west from the early part of the last century.) My concern is how any government outlays are handled, and what they are intended to do. The original Paulson plan was a total joke (gives massive power to the Treasury; does not punish mistakes; and was simply a handout to select firms (seemed like Goldman and Morgan Stanley would be the big benefitiaries.)) The real question is the details of any government spending.

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