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July 24, 2008
Fraying the Social Contract
The bail out of Bear Sterns (and before it, Long Term Capital Management) is a bad thing. As Dave (and President Bush) points out, we seem to be enabling financial addicts, giving more money to those who have demonstrated their ability to invest it badly. Perhaps the domino effect of a BS failure really would shake the financial universe to its foundations, and avoiding such risk justifies creating enormous moral hazard problems. I seriously doubt it, but I am not a finance and banking guru, so I may be wrong. Regardless, however, having the government step in to save wealthy and sophisticated investors from themselves is bad.
It is bad because beyond the moral hazard problem, it strikes at the legitimacy of modern finance capitalism. As I see it, contemporary capitalism rests on an implicit social contract. Risk-takers get to keep the upside of their investments. When they place their money on the line because they think they have a good idea and it pays, we all agree to regard their gains as legitimate. On the other hand, when you take a risk and lose, you also have to eat the downside. That is the social contract. Implicitly, I think it is what keeps envy and confiscatory populism at bay. It lets society live with the inequality that results from modern capitalism, and allows it to bustle along its way producing the wealth, innovation, and productivity that we all ultimately benefit from. Or so I believe. On the other hand, when the social contract is broken, when the risk takers get the up side and the public foots the bill for the down side, the social contract is eroded and with it the public legitimacy of capitalism. And when the legitimacy of capitalism tumbles, the communists -- or at any rate the economic populists -- come marching in.
This isn't especially original stuff, but these ideas have been bubbling in my mind for the last little while as I read about congress blaming gas prices on futures markets or proposals for "windfall profits taxes." My worry is that these aren't simply examples of your run of the mill stupid political grand standing on economics, but rather are symptomatic of a fraying social contract. It is a cost that I hope Bernanke and others bear in mind when faced with the next "too [FILL IN THE BLANK] to fail" enterprise coming hat in hand to hunker down at the public trough.
Posted by Nate Oman at July 24, 2008 02:21 PM
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Comments
The usual "too big to fail" argument is that everyone else will suffer if we don't bail out this particular set of risk-takers. Your post makes me wonder whether that mightn't be a good thing now and then. It would encourage everyone else to keep a close eye on the risk-takers and to avoid getting their own affairs too entangled with them. We just need to find someone who's not quite too big to fail.
Posted by: James Grimmelmann at July 24, 2008 03:16 PM
