Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”
The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”
[blockquote]The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem. [/blockquote]
The authors are clearly free-market fundamentalists and right-wing madmen.
“Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.”
Clearly they aren’t free-market fundamentalists or right wing madmen. Madmen would simply allow them to fail. The bankers simply know that the government can’t share the same selfish interest that they are permitted.
Well, it depends on your definition of “take over.” If the government, in the form of a bankruptcy judge and receiver, take over the firm to liquidate assets then I’m all for it. If they take it over so they can run it as poorly as Obama and his gaggle of ham-fisted incompetents are running their socialized passel of firms, then I’m against it on any number of levels.
Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse
But the dangers of not letting it collapse are probably greater than the dangers of letting it collapse – as the former will guarantee future excess risk.
We have to let some of these zombie firms go under, just to send the message. Maybe we can bail out some firms, but some have to go under, and we don’t have to be consistent about which ones are saved. We want the market to have no idea who will be saved and who won’t – just to preserve some semblance of moral hazard.