Criticising the Bailout

This post was first publishedon my blog at www.marktomarket.typepad.com.

For the past week, every financial-centered publication, website or blog has expressed some sort of reference to or analysis of the bailout, which has been discussed throughout the day in the Senate Banking Committee. The far majority of commentators have expressed concern over the $700 billion bailout, with most people being vehemently against the proposed package that Bernanke and Paulson introduced. Overall, I have to say I am in agreement with most of the opposition to bailing out troubled firms and David Merkel’s comments sum up this issue for me fairly well. With that said, some of the response to the bailout has gone way overboard, with some people talking about nationalization in a socialism sense, and when Hugo Chavez starts discussing Bush’s ‘socialist ideals,’ I know things have gotten out of control. Nevertheless, any sort of stabilization effort like this is questionable territory for monetary and fiscal policymakers, primarily due to the increased threat of moral hazard that is permeated throughout the markets as a result.

So, that’s my conservative opposition speaking about this deal. However, let me take a minute to be devil’s advocate, considering some questions that others might not think of. It’s easy to voice opposition to an economic bailout, but when I hear some of the discussion going on out there, I have to ask myself what are some of the variables involved, which might lend credibility to the argument that the proposed bailout is needed to avoid further contagion or other adverse effects to the long term sustainability of the economy.

In his testimony (linked above), Fed Chairman Ben Bernanke stated that this bailout is needed to avoid a greater likelihood of recession hitting the US economy. This argument can be re-worded to state that if the government does not intervene in the current situation, allowing wide-spread failure to occur would likely result in a higher possibility that the US economy will experience negative growth. Recession is an entirely different playing field, separate from what we are currently experiencing, and there are a variety negative consequences that come with that.

My first thought here is that while I agree with the fact that we don’t want to go into recession, Bernanke didn’t say the bailout would prevent recession. He just said that without it, the likelihood of recession is higher. So, I have to conclude (and based on my previous analysis) that there is still a good chance we will experience recession.

So, I’m not sure that is the end all/be all argument for the bailout, but I think it does exhibit how the bailout is needed for stabilization, without which, the economy will experience significantly higher declines.

Now, let me be clear that I am not against letting weak firms fail and allowing the market address this crisis in its own way (e.g., the invisible hand and all that), but let’s take a step back here and look back at the issue of the government intervening. In most cases, I am completely against any sort of government intervention … where it is not needed. Even though I believe one of the biggest factors that led us into this crisis was the fact that current regulations went unenforced, I believe the current regulatory landscape as a whole is adequate, albeit with some systematic tweaks. But, the crisis we’re facing is much bigger than your typical discussion of the government raising taxes or even bigger than intervening with the nation’s healthcare system (at least in the immediate term), and as such, the need here is significant. I am not convinced the economy doesn’t need assistance from the government.

And sure, we can also let the firms fail, but at what cost? If you look around, people aren’t exactly happy with where the economy is right now, although, I think the actual dissatisfaction has been a little inflated somewhat, as a result of the current presidential election. But, considering the cost of not bailing out the financial sector is a valid one, and I believe there is a strong likelihood that the costs of not going through with the bailout outweigh the benefits of letting the financial sector fail.

The main issue here, in my opinion, is that the public and even the markets to an extent have underestimated the overwhelming risks that are at stake if the financial sector experiences wide-spread failure. It’s not just a couple of banks going down the pike, nor is it just a matter of the markets experiencing decline. Heck, it isn’t a matter of going into recession, because when it comes right down to it, whether we like it or not, we can handle recession, even if it isn’t exactly pleasant.

I believe Bernanke is a good economist and knows macreconomic policy better than anyone. As such, I believe that he has looked at the variables and has realized that without assistance, we could see much greater systemic fall-out than anyone really understands. I hate mentioned the word ‘depression,’ but even the best economists have admitted that the financial markets haven’t seen a crisis like this since 1929. So, Bernanke sees this and his actions are to advise the President on monetary and macroeconomic policy in a way that ultimately manages the economic state of this country. As it were, the economic state of the US plays a vital role within the overall state of the global economy, so there’s a lot more at stake than banks and the housing sector. Sure, moral hazard is a concern, but we’re talking significant failures that have drastic repercussions.

So, for everyone vehemently against the bailout, I am not necessarily disagreeing with general opposition to government intervention in the financial markets through the form of financial assistance; however, I encourage people to look at the other side, and ask yourself whether or not the economy can really allow failure to occur. What are the risks at stake? And, do you think Bernanke, the NBER, the CEA, Treasury and the Administration, assisted by the best financial and economic minds on the planet haven’t considered the effects?