Why We Can't Afford Market Failure

As I have been cross-posting between Redstate.com and my blog the past two days, there has been quite a bit of discussion on the economic crisis, which both excites and concerns me. One of the key comments I have been hearing from folks over there is that we should not do the bailout and instead should allow banks to fail. Now, let me be clear that I understand the threat of moral hazard; indeed, I’ve discussed it as a key concern in this crisis and bailout discussions on this blog for the past week. However, there’s more to this line of thinking than most people understand.

I understand that most of the commenters at Redstate aren’t involved in the financial markets. While I know that doesn’t mean everyone is a financial markets and economic novice over there, I have to think about how I respond to these types of comments. One person even had the audacity to nonchalantly comment that if the markets fail, we’ll ‘just experience a depression,’ as if such an event would have no real impact on this country or its residents. Quite frankly, most of the comments I’ve read so far are from people that just don’t fully understand what they’re talking about. They comment on something as if they’re an expert, yet they don’t fully understand what they’re saying. Well, apparently many of the policymakers on the Hill are having trouble with the same problem.

This process has been so politicized and now there is the question as to whether or not the bailout will actually happen. As we’ve experienced today, it’s likely that the Paulson Plan will not pass as is. The politicians, in all of their ‘wisdom,’ on the Hill have become more concerned about how this will affect them politically, rather than thinking about the stability of our economy. They care more about their elections at this point than how the economic crisis will affect everyday people on ‘Main Street.’

Further, these politicians are clueless as to the reality of the situation. Many of them, like some people at Redstate, are arguing that we can afford to allow the markets to fail, using Lehman’s failure as an example. They also argue that we cannot afford for the Fed to bailout insolvent firms.

The reason they are clueless is because while they are making these comments, they’re completely missing the fact that the Fed has been bailing out financial firms by injecting liquidity into the marketplace for weeks now. In fact, it is now apparent that liquidity is not the problem; it’s the lack of good credit. And as a result, the equity markets are remaining stable, because the Fed has managed things effectively up to this point.

However, now that the politicians, who have no business attempting economic stabilization programmes, are doing the Potomac Two Step and interjecting their garbage into the process, ultimately preventing the Fed from doing what it is mandated by the President to do. This is the policy process at it’s worst, folks.

If you go back and look at the Fed’s balance sheet for the past two weeks, you will see that they’ve been pumping liquidity into the markets throughout this entire crisis. Lehman wasn’t allowed to fail, per se, or at least not in the sense that some uninformed people are citing. They just hit harder when the Fed padded the fall of many other firms on the breach of insolvency. So, what you saw last week with Lehman was an example of the Fed managing a crisis effectively through their authority as a lender of last resort.

The point here is that we can’t just ‘allow the markets to fail’ in the way that many people are advocating. Many fiscal policymakers (e.g., those geniouses on the Hill that enjoy pissing on our capital markets) thought this would be fine, which is why they were dragging their feet in the first place, waving letters from academic economists (which I’ve also previously discussed) who also don’t have a full grasp on the state of our capital markets. However, now they have realized the impact of their foolishness on the financial system could strike much wider systemic failure, bringing harm to every Jane and Joe in towns throughout America, not to mention other people throughout the world invested in our credit markets (whether they do it purposefully or not).

Unfortunately, Jane and Joe haven’t figured this out yet, and many of these folks are still advocating to allow failure. But, as I have explained at Redstate, these people are not removed from what is happening on Wall Street. Too many commenters act as if this crisis is only going to affect rich people in expensive suits in Manhattan. Unfortunately, that is not the case. This crisis will hit home and it will hit hard, as it has already begun to do. And, the longer we push it out, the more the impact will increase.

So, if you want to see your retirement account depleted in value; if you like the idea of price increases; if you prefer real wage decreases and Balance of Payments disequilibrium; then, by all means, continue pushing for the markets to fail. If you don’t prefer to see the value of your assets decreased, then I recommend you get behind the movement to inject rescue measures into our market. Otherwise, the fallout will be much greater than anyone really realizes.

NOTE: An earlier version of this post was originally published on my blog at www.marktomarket.typepad.com.