Beneath the Planet of the Bailouts

If you were the panicky type and I were to see a mountain lion behind you, I might lie, knowing that in this case a lie would save your life. Mountain lions think things that run are dinner. Tim Geithner, Ben Bernanke used a similar justification for keeping secrets in the Big Bailout.

When the TARP program was launched, big banks got big bailouts. That we already knew. What we did not know was which banks were in trouble. Tim and Ben decided we would be better off not knowing, so they made emergency loans to banks that were in danger of crashing (like Bank of America) and forced banks that did not need or want loans to take them anyway (BB&T).

We also did not know until recently what the Fed spent beyond TARP. Sitting down? $7.7 trillion, according to the above-cited article by 2009. We know this because of a lawsuit filed b Bloomberg under the Freedom of Information Act to force the Fed to disclose the details. An amount equal to half of everything produced in the US that year was deployed to “save the economy.” All the while, investors and the public were kept in the dark about the true condition of the banks they did business with or held stock in.

Further, banks resisted tighter regulations after benefiting from taxpayer money. I do not believe regulations are the answer to the banking problem, but it is worthwhile to note the underlying premise: Keep taxpayers on the hook for any screw-ups, and don’t limit banks’ abilities to make uber-risky deals.

A simple but enlightening way to look at this is to imagine that your household is disaster-proofed. You know that if you run out of money, it will be replaced. Let’s see…pursue a sound investment strategy balancing risk with return or invest in a wildcat plan that could make you wealthy beyond your dreams overnight with no downside? Alex, I’ll take Duh for $200. What is a “no-brainer?”

Yes, banks will act according to incentive. If there is no penalty for rolling the bones on a long-shot, they will do it every time. Under the circumstances, it is rational.

Keep in mind that there has been a mechanism in place all along to take care of businesses that fail. That happens sometimes, just as it happens in households, and it is not always due to skulduggery or rank incompetence–it is just a fact of business life. The mechanism is bankruptcy. When a business or a household cannot pay and has no prospect of being able to pay its bills, a court decides which creditors get what. Some people never get back everything they had in the deal, of course, but every one who does business with or invests in any enterprise knows implicitly that there is some non-zero amount of risk. Welcome to life.

The great thing about bankruptcy is that it allows for an orderly unraveling of the enterprise. People who did business with the enterprise will remember next time to be more careful, especially if any of the same players are involved. It is as if the economy had its own antibodies scurrying around to devour the malfunctioning cells. Some cells may get offed, but the organism as a whole stays healthy.

Under our current system, the antibodies have been instructed to stand down. In the meantime, some dunderhead up top is figuring out how to keep cells from failing. Of course, the cells do what all living things do–they grab all the resources they can. Some become big–too big to do what they are supposed to do, but the antibodies can’t do anything about it. The cells get bigger and bigger until the point where it would kill the organism to let them die. What’s a body to do?

No matter how many regulations are put in place, banks will be a hazard as long as they do not have to own their own mistakes. The current dunderheads are now suggesting that banks should be smaller. I tend to agree, but neither I nor anyone else knows for sure how big banks should be. The optimum size for banks is determined in the same way it is determined for any other type of business–by the market.

In order to fix the system, banks need to be deregulated with the proviso that they will not be bailed out. Consumers will soon gravitate toward those that have sane investment strategies, good customer service, and a reputation for honesty.

If after those changes the banks are bigger, so be it. If they are smaller, that’s fine too. It does not matter as long as they live or die by their decisions. Consumers who fail to do their due diligence may lose money in shaky banks, but the smart ones will have spread their risk out over several banks, all of which they have researched. You and I, the chattel slaves of the Washington plantation, will be free, at least until we fail once again to appreciate our liberty and lose it to the next cabal of crony capitalists. Let’s wait a while, huh?

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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