> The obvious alternative to a bailout is letting troubled financial
> institutions declare bankruptcy. Bankruptcy means that shareholders
> typically get wiped out and the creditors own the company.
>
> Bankruptcy does not mean the company disappears; it is just owned by
> someone new (as has occurred with several airlines). Bankruptcy
> punishes those who took excessive risks while preserving those aspects
> of a businesses that remain profitable.
>
> In contrast, a bailout transfers enormous wealth from taxpayers to
> those who knowingly engaged in risky subprime lending. Thus, the
> bailout encourages companies to take large, imprudent risks and count
> on getting bailed out by government. This "moral hazard" generates
> enormous distortions in an economy's allocation of its financial
> resources.
>
> Thoughtful advocates of the bailout might concede this perspective,
> but they argue that a bailout is necessary to prevent economic
> collapse. According to this view, lenders are not making loans, even
> for worthy projects, because they cannot get capital. This view has a
> grain of truth; if the bailout does not occur, more bankruptcies are
> possible and credit conditions may worsen for a time.
>
> Talk of Armageddon, however, is ridiculous scare-mongering. If
> financial institutions cannot make productive loans, a profit
> opportunity exists for someone else. This might not happen instantly,
> but it will happen.
>
> Further, the current credit freeze is likely due to Wall Street's hope
> of a bailout; bankers will not sell their lousy assets for 20 cents on
> the dollar if the government might pay 30, 50, or 80 cents.
>
> The costs of the bailout, moreover, are almost certainly being
> understated. The administration's claim is that many
[hr]
assets
> are merely illiquid, not truly worthless, implying taxpayers will
> recoup much of their $700 billion.
>
> If these assets are worth something, however, private parties should
> want to buy them, and they would do so if the owners would accept fair
> market value. Far more likely is that current owners have brushed
> under the rug how little their assets are worth.
>
> The bailout has more problems. The final legislation will probably
> include numerous side conditions and special dealings that reward
> Washington lobbyists and their clients.
>
> Anticipation of the bailout will engender strategic behavior by Wall
> Street institutions as they shuffle their assets and position their
> balance sheets to maximize their take. The bailout will open the door
> to further federal meddling in financial markets.
>
> So what should the government do? Eliminate those policies that
> generated the current mess. This means, at a general level, abandoning
> the goal of home ownership independent of ability to pay. This means,
> in particular, getting rid of Fannie Mae and Freddie Mac, along with
> policies like the Community Reinvestment Act that pressure banks into
> subprime lending.
>
> The right view of the financial mess is that an enormous fraction of
> subprime lending should never have occurred in the first place.
> Someone has to pay for that. That someone should not be, and does not
> need to be, the U.S. taxpayer.
