The price of anything is the amount of life you exchange for it - Henry David Thoreau

The Moral Problem
by Hal_10000

David Leonhardt digs up some old writing about the problem with bailouts:

Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”

The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.

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Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.

Um, that’s ain’t laissez-faire.

What they are talking is something beyond the moral hazard. They are talking about people deliberately running up huge debts knowing they will be backed up; people to whom the bailout was the whole idea to begin with. In essence, their fat bonuses and paychecks were an advance purchase against the inevitable government help. They milked these companies dry.

Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.

But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.

I’m not sure the government would be particularly good at this. The Law of Unintended Consequences is screaming when I read those words. I think a better plan is to more thoroughly punish those who commit these acts. Not only should the heads of any of these swindle factories be fired, the people who milked the system for personal gain should be permanently barred from the financial world.

I mean, defrauding a corporation and your investors because you know the government will swoop in is a crime, no?

Of course, the Obama people are already trying to make the bailouts more painful, but in what is becoming a familiar ham-fisted way.

Financial institutions that are getting government bailout funds have been told to put off evictions and modify mortgages for distressed homeowners. They must let shareholders vote on executive pay packages. They must slash dividends, cancel employee training and morale-building exercises, and withdraw job offers to foreign citizens.

As public outrage swells over the rapidly growing cost of bailing out financial institutions, the Obama administration and lawmakers are attaching more and more strings to rescue funds.

The conditions are necessary to prevent Wall Street executives from paying lavish bonuses and buying corporate jets, some experts say, but others say the conditions go beyond protecting taxpayers and border on social engineering.

Some banks are wanting to return the bailout money because of these conditions. I would like to think that is the kind of poison pill we need to minimize the bailout, but I fear this is more of the Democrats refusing to let a good crisis go to waste—and potentially creating the next crisis in waiting. Bailing out home-owners, driving educated immigrants off of our shores? Extending even more credit to the unworthy? That’s not punishing the looters. That’s punishing the people who are still holding the bag for all this—the taxpayers. Even capping executive pay isn’t that useful—it’s closing the barn door after the horse has been stolen. What we need to be doing is going after the people who created this mess with criminal complaints.

Posted by Hal_10000 on 03/11/09 at 03:43 PM (Discuss this in the forums)