I Need To Make Money At Home
Rebuttal to Opening Arguments: What should be done to improve the economy now that the economic stabilization act is ...
Bailout Should Not Become Excuse for More Bloated Government
Conclusion
The past month has been a case study of political incompetence and a sobering lesson about the need to reduce the size and burden of the federal government. Misguided policies created a housing bubble, with most of the blame belonging to the Federal Reserve's easy-money policy, the corrupt system of housing subsidies at Fannie Mae and Freddie Mac, and so-called affordable-lending quotas that extorted and/or lured banks into making bad loans. The bubble now has burst, and the economy is enduring the inevitable readjustment as asset prices return to their true levels.
To be sure, many executives and companies tried to ride the bubble too far and too long, and their failure to properly assess risk means they failed their customers and shareholders.
In other words, the financial turmoil of the past month was caused by bad government policy, augmented by mistakes in the private sector. In a logical world, the mistakes enacted by politicians would be reversed and the folks in the private sector who messed up would look for new jobs. In the upside-down world of Washington, however, the politicians have decided to expand the size and burden of government and bail out the Wall Street high-flyers.
The bailout was largely orchestrated by Treasury Secretary Hank Paulson, but his supposed Wall Street acumen has not translated in astute policy making. The Dow Jones Industrial Average was close to 11, 400 when he first claimed that the government had to intervene. Once he got involved, the market dropped and began to display extreme volatility.
But he did manage to panic Congress into approving the bailout. The silver lining to that dark cloud is that politicians finally seem to run out of ideas for new forms of regulation and intervention - at least with regards to financial markets. This should give private-sector forces an opportunity to begin to fix the economy's underlying imbalances. As such, the stock market should finally begin to climb again.
But this does not mean taxpayers can relax. The politicians and interest groups are now looking for new ways of seizing unearned wealth. The latest gimmick is to call for new "stimulus" legislation, which is based on the rather fanciful notion that the economy benefits when resources are transferred from the productive sector to government. Yet if more government spending is good for economic performance, then why are high-tax welfare states such as France suffering from stagnation and high unemployment?
The moral of the story is that the political class is first and foremost interested in expanding the size and power of government. Every time politicians get more control over the economy, they increase the pool of people who feel compelled to donate money in order to either obtain handout or avoid being fleeced. The bailout is just the latest example of this scam. The additional $700 billion in Washington is a great opportunity for politicians, lobbyists, and the special interests. They will all become richer, but the American people - the ones paying for this corrupt exercise - will have a harder time paying bills and making ends meet.
The United States has been a lucky country because our Founding Fathers bequeathed a system based on economic liberty and individual freedom. But government intervention is like water dripping on a stone. No single drop erodes the rock, but the cumulative burden of endless dripping eventually can turn a mighty boulder into a pebble. To preserve America's special status, government needs to be smaller rather than bigger.
Rebuttal
In his analysis of the bailout, John Irons makes several astute observations. He notes that the bailout grants unprecedented power to the Secretary of the Treasury, while failing to provide necessary oversight and transparency. He also notes that the Administration's original proposal to buy toxic assets was unclear, at best.
Notwithstanding these well-placed concerns, Irons endorses the bailout, stating that, "it was absolutely necessary given the rapid deterioration of credit markets and the potential impact on all working Americans." This analysis is backwards. The government's massive intervention has destabilized markets rather than helped them. When Treasury Secretary Paulson first decided to interfere with the economy, the Dow Jones Industrial Average was well above 11, 000. The remarkable volatility and sharp sell-off in the past few weeks certainly seems to indicate that the bailout was absolutely misguided rather than "absolutely necessary." To be fair, some of the market's behavior may be an overreaction. Indeed, the Administration's reckless "pass-the-bailout-or-the-world-will-end!" rhetoric probably convinced some investors to liquidate investments. It is quite likely that some of these people already are re-investing their funds now that it appears politicians and regulators have no more surprises up their collective sleeves. While it is impossible to know what would have happened to markets if different approaches were followed, it certainly seems safe to conclude that investors are greatly troubled about the prospect that politicians now will have more power over the economy.Bait and Switch
After his seemingly perfunctory - and largely misguided - remarks about the bailout, Irons then changes the subject and devotes most of his article to a call for bigger government. In the section entitled, "Addressing the crisis in the real economy, " he endorses a laundry-list of new spending and he argues that expanding the size of government somehow will create jobs. His specific proposals include:
- Subsidies for profligate states - Irons wants taxpayers to finance another bailout. This time, the recipients would be governors and state legislators. In many cases, such as California, states face fiscal crises because of a combination of excessive spending and job-killing tax increases. A bailout thus would reward politicians who made irresponsible choices. Politicians might argue that taxpayers already bailed out Wall Street, so why not hand out money to other constituencies, but we should remember what our mothers taught us in that "two wrongs don't make a right.
- Pork-barrel spending - Irons proposes big spending increases for a wide array of so-called infrastructure programs such as roads, schools, and sewers. Yet at no point does he explain why the federal government should be in charge of financing programs that belong on the state and local level. Federal involvement is an open invitation to corrupt endeavors such as the infamous Bridge to Nowhere.
- More welfare - Last but not least, Irons wants taxpayers to finance more income redistribution, including subsidies for joblessness that would encourage greater unemployment. Like the infrastructure spending, the expanded welfare spending would involve federal encroachment on areas that should be reserved for state and local government. Moreover, income distribution penalizes those who work and entraps recipients into becoming dependents.
The Oxymoron of Effective Regulation
Irons eventually returns to the issue at hand by closing his article with a generic call for more regulation and better regulation of financial markets. Because of the lack of specificity, it is difficult to respond, but it is worth noting that the financial services industry is one of the most heavily regulated in the United States. It is unclear how more regulation is supposed to solve problems, particularly when it was government policy mistakes that created the conditions for the current turmoil in financial markets.
Moreover, some regulations actually helped create the current instability. Fannie Mae and Freddie Mac, for instance, were directed by politicians to increase their risky behavior. The politicians wanted to increase home ownership and they saw government-sponsored enterprises such as Fannie Mae and Freddie Mac as convenient, off-budget, mechanisms for steering funds to favored industries and campaign contributors. In conclusion, the financial mess is a sobering reminder that government intervention often imposes a very harsh cost on the economy. This does not mean that markets are perfect. Indeed, one of the most valuable roles of the market is the process of innovation and competition that weeds out those who make mistakes (at least if there are no bailouts). Government, by contrast, is in the business of subsidizing and perpetuating mistakes.Original Argument
An Unprecedented Action
Congress has voted to give the Treasury Secretary nearly unlimited power to spend $700 billion to bailout Wall Street. The policy is designed to help financial institutions by paying above-market prices for money-losing portfolios. Taxpayers, of course, will be the ones picking up the tab. The bailout is unprecedented because of a) the approach that was chosen; b) the process that is being used, and; c) what it is intended to accomplish. More specifically: a) Regarding the approach, politicians periodically have sought to subsidize certain industries, generally by using loans, protectionism, or grants, but this is an enormous subsidy and it is the first time the financial services industry has been the direct beneficiary of significant government intervention. b) The process is unprecedented in that the bailout provides the Treasury secretary with a blank check to decide what assets to buy and how much to pay for them. Congress attempted to address this concern with provisions such as a congressional oversight panel, but cosmetic gestures will have no meaningful impact on the process. c) Last but not least, the bailout is intended to reward managers and shareholders on Wall Street - groups that traditionally do not get much sympathy from politicians - who made poor decisions.
The bailout has generated considerable debate, both from a philosophical perspective and a practical perspective. The philosophical issue is fairly straightforward, with critics from all parts of the ideological spectrum complaining that the bailout is misguided. Conservatives and libertarians, not surprisingly, condemn the bailout because it represents a significant intervention by the government in the private economy. They argue that the proposal will not work in either the short run or long run, and that it is instead likely to cause additional economic damage. Liberals and populists, by contrast, have no objection to intervention, but assert that government largesse should be directed at parties other than the Wall Street executives, shareholders and institutions. It already is becoming apparent that the short-run argument for the bailout was erroneous. The Dow Jones Industrial Average plunged several hundred points the moment the bailout passed on Friday, and this week began with a huge plunge. To be sure, not all of this bad news may be due to the bailout, and it also is true that psychological factors can drive short-term stock market performance (especially the "Keynesian beauty contest, " where speculators try to guess the outlook of other investors rather than assess the underlying value of companies). Nonetheless, it certainly appears that financial markets are less than enthusiastic about the bailout - which is rather surprising since the Administration irresponsibly encouraged a falling stock market before the vote by claiming that the bailout was necessary to prevent a meltdown. While this tactic was reckless from an economic perspective, it presumably was smart politics since it maximized the possibility of a rising stock market after the bailout. Credit markets, meanwhile, have not responded positively - at least for those who think that a return to anything-goes lending standards would be a step in the right direction.
The Long-Run Negative Impact
If the short-run news is bad, the long-run outlook is even worse. The issue is not whether the bailout will work, but rather how much damage it will cause. This is because the bailout represents a substantial increase in the burden of government, both directly and indirectly. This unavoidably means that the United States will enjoy less economic growth in the future. Key problems with the bailout include:
- Creating Uncertainty: To avoid the mistakes that Japan made in the 1990s, bankrupt firms should be allowed to fail and over-valued assets should be allowed to fall to the market price. These steps clean out the system and allow a strong rebound. This process will be hindered, however, by the bailout. Moreover, because nobody knows which "toxic" assets will be purchased, the damage will be compounded by an additional layer of uncertainty.
- Moral Hazard: The current turmoil in financial markets exists in part because the corrupt subsidies from Fannie Mae and Freddie Mac encouraged private investors to engage in riskier behavior. The bailout rewards this excessive risk and will lead investors in the future to be even more imprudent.
- Misallocation of capital: Myriad subsidies and preferences have encouraged over-investment in residential housing. One potential silver lining to the dark cloud of financial turmoil is that capital and labor will shift to more productive uses. The bailout will hinder this shift. More generally, the bailout means political forces will become more important in determining the allocation of investment, further undermining market efficiency.
- Opportunities for Corruption: By giving the Treasury Secretary a $700 billion slush fund with almost no guidelines or rules, the bailout will dramatically increase the power of the lobbying community and lead to an orgy of influence peddling. The haphazard nature of the bailout also has negative implications for the rule of law, which will further increase the power of Washington.
The Real Problem
To add insult to injury, the bailout is being portrayed as a necessary step to clean up the mistakes of the free market. Yet the main causes of the bailout - easy-money policy by the Federal Reserve, corrupt subsidies from Fannie Mae and Freddie Mac, and other housing preferences - are all mistakes by government. Many people on Wall Street did get greedy and tried to profit from the government-created bubble, but they already are getting their just desserts (or at least would be in the absence of a bailout). Politicians, though, get the best of all worlds. Their policies created the bubble, which led to the current turmoil, and they have used the turmoil they created to grab even more power over the economy. The best we can hope for is that politicians do not cause additional damage. A stock market correction was turned into a Great Depression in part because politicians raised tax rates (Hoover and Roosevelt), increased spending (Hoover and Roosevelt), interfered with private markets (Hoover and Roosevelt), and imposed protectionism (Hoover). Given the lack of economic knowledge in Washington (or the disregard of knowledge if it interferes with the pursuit of political power), there are many reasons to be pessimistic.
The Real Solution
So what should be done? In an ideal world, the bailout would never have happened. Bankrupt institutions would have been allowed to fail. Asset prices - especially housing - would have been permitted to fall. The market, if it had been allowed to function, would have addressed the problem. Some have called this the "pain-is-good" plan, but it would be better to call it the "don't-make-things-worse" plan. The key thing to understand is that pain is unavoidable once a bubble is created by government mistakes, but the way to minimize the damage is to let market forces quickly operate. This does not necessarily mean that the government is totally absent from the process. Since bankruptcy law is ill suited to financial institutions, the Federal Reserve and Federal Deposit Insurance Corporation have the ability to handle insolvent institutions while generally protecting the interests of customers. This is basically what happened with Wachovia, Lehman Brothers, and Washington Mutual (and to a lesser extent with AIG and Bear Stearns). This approach may not be perfect, but it is much preferable to the bailout since shareholders and management are penalized rather than rewarded for their mistakes. While market forces are the best way of dealing with the problem, particularly with the Fed and FDIC facilitating the orderly merger/liquidation of insolvent institution, the bailout interferes with this process. It will subsidize bankrupt institutions. It will prevent asset prices from returning to market levels. It will cause uncertainty as investors, lenders, borrowers, and others play a guessing game as they wait for the Treasury Department to use its $700 billion piggy bank. And it presumably will supplant the Fed and FDIC from their relatively benign activities. But since the bailout already has been approved and there is no chance that politicians will admit their mistake and repeal the measure, it still leaves the question of the next step. The answer does not change. Market forces are still the best way to clean up the mess created by government. The bailout throws some sand in the gears, but that simply highlights the importance of letting the market operate as soon as possible.Conclusion
Relying on the market does not magically preclude economic dislocation. Government policy mistakes made turmoil inevitable once a bubble was created. As noted above, the real issue is how to minimize pain. The Japanese experience in the 1990s is very instructive. Japan had a bubble, and politicians responded to the bursting of that bubble by trying to prop up insolvent institutions and trying to keep asset prices artificially high. That was a big mistake, and Japan suffered a lengthy period of economic stagnation. By approving a $700 billion bailout, American politicians took a first step in that direction. Hopefully, it will be the last.
Opposing Argument
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