Tyler Cowen asks this question on his blog today in the wake of Ben Bernanke’s renomination to the top post at the Fed. Were the bailouts a good idea? It’s a question that libertarians tend to answer with a gut response of “No!” Well, I guess I should say that most libertarians respond negatively.
I am certainly on record on this blog and in my articles as critical of the bailouts (as is everyone at Reason). And my tendency since the meltdown last fall has been to argue that the bailouts were a bad idea. But I think intellectual honesty requires more than a flippant answer to this question.
My view, in short, is focused on two issues: moral hazard and creative destruction. The moral hazard of continuing the policy of too big to fail means we are rebuilding our economy right now on a bed of sand. And the bailouts maintaining the current structure of the financial system means that those who deserved to fail didn’t, and bad business models (and bad business leaders) were preserved. This means the reallocation of resources in the market place that the recession was trying to complete didn’t happen and the economy will suffer as a result. Back in September of 2008 I wrote:
Ultimately, the debate over what to do comes down to a threshold of pain and perspective. Capitalist philosophy suggests that short-term financial pain—even a great degree of pain—will prevent long-term financial destruction. The markets, in other words, are going through a cleansing process.
But, I admit, that this view is stuck in the academic world. It is answering a debate question outside the reality of the American system in the 21st century. And that is the perspective that Cowen is trying to bring to the table. Tyler Cowen argues that the bailouts not only helped the economy by helping the banks, but they prevented worse government intervention in the market place:
Without the bailouts we would have had many more failed banks, very strong deflationary pressures, a stronger seize-up in credit markets than what we had, and a climate of sheer political and economic panic, leading to greater pressures for bad state interventions than what we now see.
This perspective, that not having the bailouts would have trashed the markets (agreed) leading to worse things from the government is an angle that should be taken seriously. After all, the libertarian argument is that the short-term pain from letting banks fail would result in long-term stability, but that assumes that the government uses the short-term failure to make the right changes. Thinking about it in political terms, there is a logical argument to make that regulations would have swung the other way and we’d be facing more intensive attempts by the government to take over the financial industry. Cowen writes to make this point:
But if anyone should know that modern politics can only stand so much short-run panic, it is libertarians and fans of Bryan Caplan’s book. If we had not done the bailouts we did, we would, within a few months’ or weeks’ time have received a much worse and costlier bailout run by Congress and Nancy Pelosi.
The Marginal Revolution commenters take him to task on this point. “John” writes: “in the near term we all breath a sigh of relief, but projecting into the future we must accept the fact that we had an opportunity with this crisis to cease the perpetuation of a boom-bust-cycle and missed it.”
Recounting the classic story of learning not to touch hot stoves from experience instead of having your mother slap away your hand (the bailouts), “Mike” writes: “The moral of the story is that assuaging pain is great, but pain is the most universal teacher we have in our society. It makes us pay attention and provides a highly concrete incentive to stop performing an action. So, I think that the stage would be set for greater regulatory change if less bailing out had been done.”
Yet, these explanations do not write off Cowen’s contention that the government response to additional bank failures would have been worse than the bailouts. Megan McArdle chooses to back up Cowen, simply saying:
There are things about the bailouts that could have been done better; I think both Democrats and Republicans demanded too little from the large banks in return for its support. But the basic strategy seems like the best option in a bad situation.
Libertarians will often favor a “bad” option because it is better than the other options. You may not like that classical liberal philosophy chooses not to help the poor by setting minimum wage laws, but ultimately it is because minimum wage laws hurt the poor and increase unemployment. Cowen is arguing from the same perspective, making libertarians pro-bailout from the vantage point of anti-worse-bailout.
Since the bailouts were in September ’08, and we technically didn’t know who was going to win the Presidency or if the Democrats would win 60 seat in the Senate, then I think it is still fair to say that libertarians should have opposed the bailouts on the grounds that we don’t know what hypothetical worse bailout might be coming. Then again, politically, I don’t know how much different economic policy would have been with McCain in office instead of Obama, not to mention that the democrats were likely to be dominant in Congress one way or another.
Thus, in hindsight, it can be argued from the anti-worse-bailout perspective that the bailouts were not a bad idea. But this is a means to an end sort of argument, and those don’t pan out well in ethics classrooms. Philosophically, the moral hazard of bailouts, not to mention the use taxpayer money to prop up the banks (theft as Rand would say), means they were still a bad idea. The fact that the government might make money off the “investments” is totally beside the point in terms of arguing the bailouts were a good idea because those gains are as fickle and impossible to predict as any dollar invested on Wall Street.
I think a related question that would be interesting to ask is: are the bailouts acceptable because they were the best answer to a system that was not ideal? In other words, because of screwy regulations, government policy promoting home ownership, rouge GSEs, and financial institutions banking on too big to fail policy, was the system itself was so flawed that no pure market solution would save the day?