Looking Back at the Bailouts

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Now that we have the benefit of hindsight, what should with think about the bailouts?  A large number of conservatives and libertarians are against them.  I think that a large number of liberals are too, though for different reasons.  Both dislike giving state money to companies, but the right worries about the tax burden and the corrupting influence of government on the market as much as the corrupting influence of companies on the government.  They are also, I think, more worried about moral hazard, while liberals worry more that the money spent on banks can't be spent on other government programs.

All these concerns are correct.  The bailouts have probably substantially increased moral hazard, and perversely, arguably undermined the political will for regulation that might reign in that moral hazard.  Top investment bankers really do seem to have a worrying about of influence over Treasury and the Fed.  The tax burden is large, and should worry you whether you wish that money had been spent on food stamps, or returned to taxpayers.

That said, they were probably the best thing we could have done.  If you disagree, you need to sketch out a plausible alternative scenario.  Tyler Cowen poses the question for libertarians:

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.  Milton Friedman understood all this quite well, which is why argued bailouts would have been a good idea in the 1929-1931 period. 

(By the way, some libertarians like to pretend that Milton Friedman blames the Fed for "contracting" the money supply by one-third in that period but in reality Friedman blames the Fed for having let the money supply fall by one-third and not having run a bank bailout.)

If you are a libertarian, is not our current course more favorable for liberty than would have been a repeat of 1929-1931?  If not, I would be curious to hear your counterfactual version of how matters would have proceeded, without the financial bailouts.  Is it that you think the regional banks would have raised the financing to pick up the entire bag and keep the banking system afloat?  Or is it that natural market forces would have somehow avoided a wrenching surprise deflation?  Or do you think the authorities for some reason would have not nationalized the major banks?  Please let us know.

Maybe you think that the bailouts will have disastrous long-run consequences.  And maybe they will, I worry about this too.  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.  How does that sound?

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.  On the other hand, maybe this is an argument for liberals that we shouldn't have done the bailout . . .


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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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