Don’t Look! There’s Nothing Behind You!

More and more, ahem, interesting things are coming out about the financial crisis. Records that the Fed and our biggest banks wanted to keep secret have been released, showing just how much and to whom the Fed’s money went.

Ostensibly, the intent was not to prompt a panic. I am not impressed with that explanation, and you shouldn’t be either. It amounts to lying to shareholders about the financial condition of an institution in which they have invested. A private company trying such shenanigans would be in hot water big time.

When a country’s leaders are willing to lie and hide information, especially about something that affects every American deeply, it is time to take a hard look at the system itself. Thousands upon thousands of small business owners are dying on the vine because credit has dried up. Yet big banks are shoveled truckloads of money because they are “systemic” risks.

Let me translate that for you. Markets weed out poor competitors, and yes, some people do get hurt. If a bank you have stock in or do business with goes under, you as an individual are hurt. If that happens, though, the surviving banks do two things: 1) they get your business and 2) they know that if they screw up, no one will save them.

Since the early 1970’s, government has bailed out an increasing number of large companies, reasoning that having them go under would damage the economy as a whole. In 2008 was added the element of secrecy–no sense scaring everyone and tanking stock prices, right?

Neat trick, that. If I can rely on government (read “taxpayers”) to bail me out, will I take on more risk with the possibility of making a fortune, or maintain reasonable risk with the intent of keeping the company solvent? Tick, tick, tick…Ready to answer? You win! More risk every time, especially if no one knows I was bailed out.

The seductive part of this arrangement goes well beyond the big companies themselves. Every time it happens, a bailout can be vaunted as having saved the financial system. Of course, if you think it through, there is no evidence that can be offered in contradiction. Say the right chant and your cold will go away in a few days. When you are better, prove to me that it wasn’t the chant that did it. See? Even those opposed to bailouts in principle often shrug and say it was the only option.

Now that our financial system is leveraged to the hilt and drowning in debt, the people in favor of bailouts are unfortunately right. Some institutions have become so big that their demise would disrupt the whole planet’s financial well-being. The question we need to ask ourselves is, “How does a company get so big that it can hold the world hostage?”

The answer is in a book I am just now finishing: Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.* Fannie Mae and Freddie Mac, the mortgage giants that we now own as taxpayers, became the crumbling behemoths they were not through sound business practice, but through a shameless and powerful lobbying machine. If ever there were a story to set one’s mind astir with visions of how badly our government has infected the private sector, this is it.

Too Big to Fail is a phenomenon that literally cannot happen without the enabling hand of government. No company that engaged in the kind of bizarre loans and byzantine derivatives that our biggest banks did could long survive were it not for the implicit guarantee of government. Banks made stupid loans, sold the paper to Fannie Mae, and then went on to make more stupid loans. When poop hit the propeller, guess who was on the hook for the billions of dollars in bad loans? Yep, that’d be you and me.

Markets are the whipping boy of statists everywhere, but markets are the mechanism through which businesses are tempered and tested. Those that survive are the ones that, by and large, do business honestly and well. Government, contrary to the statist view, is not the Guardian of Justice but the Whore of Babylon. More regulation is not the answer; less involvement is. When businesses know that they live and die by their own decisions, they will make better decisions. When we remove government from involvement in business, we remove the cancer that infects our financial system.

Unfortunately, removing the cancer will be painful. Our financial system is a sham, one in which we are all invested one way or another. After surgery, it will take months, probably years, to heal. If we refuse to admit the source of the disease, we will never get well.

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*Disclaimer: I no longer am an Amazon affiliate. They have discontinued that program in IL because they rightly refuse to collect sales tax for the state.

 

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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2 Responses to Don’t Look! There’s Nothing Behind You!

  1. JJ says:

    We have privatized the profits that companies (and their executives make) and Socialized the losses. Why wouldn’t they take the risk? I think that government has a role in forcing transparency so that the markets can do their work. Consumers and investors can’t make informed decisions without that information. By the way, that information includes the vertical and horizontal integration of companies and all their global relationships. If we as consumers and investors decide to support these “too big to fail” companies then we should suffer the consequences if they go under.
    jj

    Like

  2. James says:

    When I hear the words, “Too Big to Fail,” the term translates in my mind to, “Too Big to Be Allowed to Exist.”
    If a company truly has that great of an effect on the economy, it needs to be shut down – or at least broken up, as the old AT&T was – before systemic rot causes it to collapse under it’s own weight.

    Every management decision of a publicly-traded company should be made public as a matter of course – there should be no skeletons left in the closet, Corporate Espionage and Trade Secrets be damned. As Consumers and Investors, we have the right to know what decisions are being made on our behalf or in our names. . .

    Like

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