I sat this weekend and pondered the pending financial bailout. A number of fairly smart people who know more about Wall Street than I seem to think it a necessary evil, and this includes several folks who are nearly as libertarian as I. Is a sort of knee-jerk libertarianism preventing me from accepting a necessary step to avert economic Armageddon?
I don't think so. By the light of day on Monday morning, I still think it a bad idea.
Here is some of my thinking (to some extent my last point is the one that is most important to me -- if we want liquidity, let's put it in the right place).
- I am tired of businesses heading to the government bailout trough and arguing that the continued functioning not only of their industry, but of all the existing players in their industry, is critical to the health of the US economy and thus requires some sort of government subsidy/bailout/protection. Coyote's first law of rent-seeking is that companies will always claim that failure of their business will have a disproportionately negative effect on the economy. Coyote's first corollary to this law is that Congress usually accepts this argument at the exact point in time when it is no longer true.
- This bailout is even more grotesque than a normal industrial bailout. GM can be said to have honestly tried to make the right cars, and just failed. I don't like bailing them out, because I don't particularly like diverting capital into the hands of organizations that are proven failures at using capital well. But the financial investors that we are bailing out today knew they were taking a lot of risk by purchasing risky securities and then leveraging them up on their balance sheets. They lived high for years off of the fat returns for taking this risk, arrogantly explaining that they made lots of money because they were smarter than everyone else and because they were being rewarded for taking on risk. But then they come running to the government when the returns on their risky securities turned south, which just makes me sick. They were paid for taking this risk, so take it. I am sorry that you have no cushion because all those earlier returns are already spent on Maserati's for your mistresses, but that is what chapter 7 is for.
- As many as 300,000 small businesses go bankrupt every year (this number is very, very hard to pin down, as it is hard to separate personal from business bankruptcy with small business). Something like 299,998 of them do not get bailed out by the feds. Why do the other 2 get special treatment vs. other US taxpayers? Because they are better at lobbying Washington that they are essential?
- Yes, the government created the Alt-A and sub-prime mortgage markets,and caused them to flourish via Fannie and Freddie aggressively asking for and buying these loans. And the feds, via tax policy, and local governments, via zoning, helped pump up the housing bubble. But nothing forced private companies, particularly highly leveraged institutions like banks, to load up their balance sheets with these things, or, crazily, to write insurance policies on their value. Libertarians want to use these government interventions as an excuse for the bailout, but it doesn't wash. I do think many banks reasonably have lawsuit material against ratings agencies Moodys and S&P, which is fine. I think new blood in that business would be a very good thing.
- The total market capitalization of traded equities of public corporations on NYSE and NASDAQ is between $15 and $20 trillion. That means that the first $150 billion of the bailout is equivalent to about a 1% price move on the exchanges, something that occurs almost every day. Have we really close-coupled everything so tightly that a cumulative balance sheet hole on the order of magnitude of a 1% move on the stock market can bring down the whole financial system? If so, we should just let the whole thing come down and rebuild itself in a more robust form.
- Wall Streeters pat themselves on the back all the time for how creative they are financially. So get creative here. Create some sort of new entity and have banks contribute toxic mortgages into the entity in exchange for equity. Find some pension funds to invest in the new entity at a deep discount.
- These banks, who are experts in this stuff, claim they cannot value these failing, complex, illiquid mortgage packages. OK, that may be true. But how is the government possibly going to do any better? Such a situation cannot possibly end well for the taxpayers.
- I saw folks writing in fear last week that the commercial paper market might dry up. The commercial paper market dries up all the time. It comes back eventually. People treat lending markets like they are charities or something, and they fear that lenders will give up and never come back. But they are not charities. They serve just as much of a purpose for lenders and for borrowers. Businesses and folks with capital need to make money on short term cash. They are not going to stop lending forever. Even capital markets dry up from time to time. The IPO market has disappeared several times, including several years in the post-Internet-bubble period. The junk bond market comes and goes.
- What is the government really worried about? I presume that they are worried that liquidity will dry up and the ability of main street businesses to borrow will be impaired. OK, then save the freaking $700 billion and if main street starts to have trouble borrowing, have the government participate somehow in that lending market. Buy corporate bond issues, and/or increase the limit on SBA loan guarantees by a $100 billion (this latter would allow a million new $100,000 SBA loans, and would actually generate money now in guarantee fees and only potentially cost money much later if the loans fail). This way, we are investing liquidity in successful companies trying to grow rather than in failing banks that got us all into this. Let's invest in success rather than in failure.