This post was first publishedon my blog at www.marktomarket.typepad.com.
I previously played devil’s advocate in the discussion over all of the criticism floating around out there on the bailout. I have a few more thoughts, some of which may sound like devil’s advocate to my previous thoughts. Confused? Me too, but it only gets worse from here.
I’d like to pick up on the subject of allowing the financial sector to fail. Previously, I argued that the threat of systemic risk in this situation could outweigh the concern over moral hazard developing from government intervention.
As I was thinking about this, I had to ask myself what started this whole crisis. There are two key sources: first, there were poorly managed market and debt instruments abused by private agents (e.g., firms and consumers); and, second, there were a set of regulations that went overlooked and unenforced when said market/debt instruments were abused.
Months ago, I was surprised to find myself in the camp that said there were insufficient government regulations, only to later realize (read come to my senses) that the regulations out there right now are just fine … assuming they’re properly managed and enforced. But, one of the key issues that I think all of the commentators out there have missed is that the regulations are in place to prevent crises from emerging. Well, in case you’ve been in a cave for a few weeks, you should know this crisis is well underway.
This crisis is the brood of the markets. We made it. Government allowed it. This is why I think there’s actually some legitimacy to the bailout, because the government’s assistance to fix something it allowed in the first place is not so much out of the realm of possibility in a market-driven society.
As people are calling for the heads of Dick Fuld and other allegedly inept managers of financial firms, I think we should consider this. It was only a few months ago that the markets and shareholders were praising Dick Fuld for the amazing amount of value that was created for Lehman under his leadership. How quickly things change in the markets, huh? So, that’s no surprise, considering everyone knows that life on Wall Street only exist from one quarter to the next; however, I find it hard to place all of the blame on people like Fuld and his cohort.
You see, these firms’ managers were responding to shareholder demand, attempting to create value and extend their lifetime for one more quarter. Now, don’t get me wrong – these managers aren’t free of blame (and many are indeed inept), because attempting to create value for shareholders does not make these firms exempt from regulations. But, think if you were walking down the street and someone offered you a one-hundred dollar bill for nothing in return. You’re likely going to accept it, say thank you and move on. You’re probably thinking about how that $100 will help with rent, or go towards tuition, or purchasing that iPhone or whatever. You likely won’t be thinking about how you’re going to report this chunk of cash on your tax returns. The key here is that just because you don’t think about how you’re going to report that money, doesn’t mean the question won’t come up the weekend before April 15th.
So, I realize it’s a laughable analogy, but the point is these firms and their leaders took the short-term gain compromising long-term risk. Well, the risk came back to bite them, which begs the next question: why did this come full circle?
The easy answer is that it always comes full circle at some point (e.g., what goes around …). I mean, the macroeconomy is a cyclical beast; therefore, it was bound to happen at some point, right? Absolutement. And as such, all of those managers do indeed breed a sense of ineptitude, because they should have known it would come back to bite them at some point.
But, the question remains: what were the reasons this came back around now? This is where the blame on the system comes into play. If I have been sounding like I am completely defending monetary policymakers’ actions, then I haven’t effectively communicated my message. I am, to an extent, defending their actions related to the bailout, but that doesn’t mean they’re without fault when it comes to the original causes of the crisis. I guess what I am saying is that since they allowed this situation to get really bad, then perhaps they should be responsible for fixing it.
Above I said that we (i.e., the markets) caused this crisis, but the regulators allowed it. So, in summary, we’re certainly all to blame, but the regulators should indeed be expected to intervene. As such, I don’t look at their intervention as unnecessary government intervention threatening with increased moral hazard; instead, I consider the onus to be on regulators to step up and do their part to fix this crisis.
In the end, everyone is Monday morning quarterbacking and we’re all experts when we try to over-simplify a situation that is more complex than anyone can possibly imagine. But, I think this is another viewpoint that Bernanke & Co are considering, because they realize that regardless of the who’s and why’s in the creation of this beast, something must be done to contain it. So, we can talk all day long how bailouts are against capitalism and claiming the government is turning socialist, but in reality, we’re talking about making sure those massive layoffs on Wall Street don’t translate to massive layoffs on Main Street.
I guess what I am saying is let’s fix it and move on. Is government intervention preferred? Of course not, but the central bank’s role as a lender of last resort is there for a reason, namely if things get to the point where we are currently at, then intervention is not unwarranted. More importantly, the government cannot fix this on their own. Regardless of the price tag on the bailout, it will inevitably cost more than what the government is putting up right now. And yes, taxpayers will foot the bill to an extent. But, we have to move on. Further, we will overcome the moral hazard blues, although, I am sure it will be another challenge in the whole mix of things going on, but I think this is something we can deal with, whereas widespread systemic risk is not at this time.
Even though I am not thrilled with how this has transpired and I would love to jump in bashing all of those involved, but another part of me says forget all of that and let’s actually move on to fix things.