Unconditional Bailouts: Capitalism’s Undoing
posted by Frank Pasquale
What are we to make of Bob Ivry, Bradley Keoun and Phil Kuntz’s blockbuster report on the Fed’s bailouts? The three journalists conclude that “taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger.” Yves Smith argues that “banks lied” and grabbed $13 billion in profit. She also notes that their favorite water carrier, Timothy Geithner, “told Congressmen they were too stupid to be able to shrink banks, and they should leave those questions to the Basel Committee (which has no interest in making big banks smaller).”
For another perspective on the corrupt relationship between megabanks and our central bank, consider John Kay’s recent description of the “martingale” strategy among bettors:
Each time you lose, you increase your stake: to the point at which a win on the next game would recoup all your losses and leave you ahead. Since you will win sooner or later, you are certain to come home with a small profit. Provided you are infinitely rich before you start. Otherwise, if you regularly engage in martingales, you will eventually go bankrupt – and the richer you are, the larger the scale of bankruptcy.
Since anyone who studies the problem knows that ruin is the outcome, your bank, or your bookmaker, will probably call a halt to the game while the shirt remains on your back. Such capitulation will leave you with a large loss, and an enduring grievance that others have deprived you of a great coup.
As financial instability continues, we can count on a few things. Some will lose, and some gain, a great deal. Troubled companies are going to gamble on resurrection. As long as they have an infinite backstop from a central bank, they may well succeed. Peter Boone and Simon Johnson describe how a “doomsday cycle” of privatized gains and socialized losses continues to this day:
[M]ajor private sector firms (banks and nonbank financial institutions) have a distorted incentive structure that encourages eventually costly risk-taking. Unfortunately, the measures taken in various US and European bailout rounds during 2008-2009 (and again in 2010 for the eurozone) have only worsened, and extended to far more entities, these underlying moral hazard incentive problems. . . .
This cycle of boom followed by bailouts and bust amounts to a form of implicit taxpayer subsidy that encourages individual institutions to become larger – and the system as a whole to swell. Our preparation to bail out their creditors means systemic institutions are able to raise finance cheaply in global markets. The implicit subsidy to creditors encourages greater debt, which makes the system ever more precarious.
As various economists contest the value of the financial sector, the critical role of “too big to fail” (TBTF) status needs to be front-and-center. Paul Krugman recently concluded that the economic crisis “showed . . . the apparent value created by modern finance was a mirage.” I would say that it was not the crisis, but the response, that confirmed this. A system that socializes losses, but privatizes gains, is not free enterprise. As Dean Baker observed of the bailout of A.I.G. in particular, the policy “ensure[s] that [financial institutions] suffer[] no consequences from their mistake[s].”
As I noted back in the summer, the US must choose between guns, butter, and continuing to support the gambling that keeps too-big-to-fail banks flush. Many of those who made great fortunes from that gambling are bankrolling an anti-revenue movement that pledges never to allow their taxes to rise. The guns are called essential due to arms races, terror threats, and humanitarian missions, real and imagined. The butter is on the chopping block. Abandoned homes and crumbling roads and bridges are the rubble left by the martingales of a self-aggrandizing elite. They would rather see mass homelessness than suffer a tiny financial transactions tax that could address that problem (and many others).
A final note: I’m not saying here “fiat justitia, ruat caelum.” A lender of last resort must, on occasion, lend as a last resort. All I am saying is that it is deeply troubling for anyone to reconcile themselves to the Fed’s (and the Treasury’s) vast emergency powers without simultaneously demanding that those powers are used to sharply limit the pay and prerogatives of those at TBTF institutions, and to help ameliorate the economic devastation they’ve caused.
Photo Credit: Melissa Gray.
November 28, 2011 at 9:07 am
Posted in: Corruption, Financial Institutions, Law and Inequality
Print This Post
Responses (6)
Ken Rhodes - November 28, 2011 at 10:22 am
Repeat after me: Forget Dodd-Frank; repeal Gramm-Leach-Blibley; bring back Glass-Steagall. (I think I may have sung this song before.)
A couple of specific comments:
(a) In re the Martingale strategy — the banker or bookmaker halts the game, not because ruin is the inevitable outcome *in theory.* Au contraire, a random walk will eventually cross any positive line, even when the individual event bias is negative.
Ruin *in the real world* is inevitable because the banker or bookmaker is not willing to lend you unthinkably large (virtually infinite) sums just to let you continue your random walk while you’re on the negative side.
(b) Krugman’s conclusion was that economic crisis “showed … the apparent value created by modern finance was a mirage.” I would restate that as the crisis reinforced the truism that the apparent value created by modern finance was a mirage. Was it not apparent to anybody who thought about it that “modern finance” was not creating any more goods and services than “old fashioned finance,” but merely churning the pool of money, with rent-taking by the churners?
(c) I assume the last sentence of your next-to-last paragraph has a typo — “task” where you meant “tax.”
Frank Pasquale - November 28, 2011 at 10:28 am
Thanks, Ken…all good points…and I have now corrected the typo.
A Conservative Teacher - November 28, 2011 at 1:07 pm
You are so right- this type of government meddling in the economy is going to lead to the failure of capitalism. Communism and fascism, as seen by the increasing allinance between Big Government and Big Business, are going to kill capitalism, which has made America such a great nation and done so much to raise the quality of life for millions and billions around the world.
You are so right- we need to end government spending and involvement in the economy and return to a nation that is free to grow and propser without government picking and choosing leaders.
Barack Obama, Tim Geitner, and Chris Dodd- the main people who beneifited from campaign donations by Wall Street- need to be thrown out of office so new and different people can return us back to capitalism. Great blog post!
Brett Bellmore - November 28, 2011 at 6:03 pm
But are these really unconditional bailouts? Or is there some kind of quid pro quo going on in the background? Maybe the sort that’s responsible for elected federal officials magically becoming wealthy over the course of their careers?
rapier - November 28, 2011 at 10:11 pm
The government, including the Fed, has created a system in partnership with the giant banks which has supplied the US government with approximately $5 trillion dollars in virtually zero interest rate credit the last 4 years. If those banks were allowed to fail then so too would the US government. To wit all the wailing and gnashing of teeth about the Super Committee was about cutting only 10% of deficit at current borrowing levels. Little more than a rounding error. Absent the giant banks the issue would not be choosing to slash the deficit it would be having to because the money could not be borrowed. In which case the political economy as we have known it for 60 years would end. And so too of course would be the power and wealth of our government and corporate elites.
In every possible short term allowing the financial sphere to live on untouched is always the choice. The financial/banking/credit system may dislocate on its own but there is no possible way the political system will even start to reform it. Reform is not possible for reform is death.
Federal borrowing the last three years has been over 10% of GDP. Absent that borrowing, and spending. GDP would have been off a good portion of that. In other words a true depression. The government needs the money lenders just as much as the money lenders need the government. In truth there is no separating them now.
Brett Bellmore - November 29, 2011 at 7:29 am
All I can say is, if banks aren’t allowed to fail, isn’t it time we dispensed with the FDIC insurance, which exists only to aid depositors when banks fail?
No, wait, I can say one more thing: “Absent that borrowing, and spending. GDP would have been off a good portion of that.”
Can we really be so sure of that? When a good deal of the borrowed money goes to expenditures chosen for their political, not economic, benefits, or is merely laundered inefficiently through doomed corporations headed by the politically connected, like Solyndra? The typical assumption here is that the government could pay people to dig and fill holes, and it would have a positive “multiplier”. But I think it’s time we considered the possibility that much of government spending, especially that labeled “stimulus”, has a multiplier less than one, or even possibly negative.
In fact, the economic performance over the last few years was significantly worse than the no-stimulus economic projections. Either the models are worthless, or the stimulus was less than worthless.
Leave a Reply