Today marks the 1-year anniversary of Bear Stearns’ bail out. To help visualize what could have taken place, check out the following video:
Many still wonder why we bailed out Bear Stearns. Most individuals, including myself, detest bailing out the big-time wall street powerhouses. My reasoning, “Why should we spend tax payer dollars to save excel-jocks who made laughably bad bets?”
In today’s Wall Street Journal, James Freedman recognizes this and once again poses the question, why bail out Bear Stearns?
It all centers around one analogy by Federal Reserve Chairman, Ben Bernanke:
“If you have a neighbor, who smokes in bed, and he’s a risk to everybody. If suppose he sets fire to his house, and you might say to yourself, you know, ‘I’m not going to call the fire department. Let his house burn down. It’s fine with me.’ But then, of course, what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood? Well, I think we’d all agree that the right thing to do is put out that fire first, and then say what punishment is appropriate?”
First off, if we’re talking about Bear Stearns, the neighbor was most likely smoking pot, not cigarettes. Second, I’m loving how our Fed Chairman is likening big financial institutions to contagious house-fires–and everyone’s ok with that. His analogy helps put things into perspective.
The financial system is a core component of the economy’s success or collapse.
Think about that statement. It’s critical. The reason why small firms aren’t bailed out, as well as firms in other sectors, centers on the post-condition.
Scenario I: Financial Institution Collapse:
If the Fed let all financial institutions collapse, there would have been another great depression–if it was a movie, it would probably capture the title, “Great Depression II: Yea, No Shit.”
In addition to this, many “financiers” would be left jobless. Imagine young, minted, Harvard grads holding card-board signs on a street corner. What else would they do? Go back to grad school for a second MBA?
Scenario II: Search Engine Giant Collapse:
If Yahoo collapsed, would the Fed bail them out? No, and for two reasons:
- (i) The collapse of Yahoo would only help another player in the sector (like Ask.com or MSN), take on Google, which engenders a more competitive sector
- (ii) Yahoo employees wouldn’t stand around on a corner with their thumb in their mouth—they’d become entrepreneurs; thus, building the economy
Bottom line: Big banks must be bailed out because, (i) they’re contagious–yea, I would even liken them to a disease, and (ii) many ladder-climbers left jobless from banks don’t have the capacity to become entrepreneurs.
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If you don’t provide financing for big banks balance sheets (remember these are loans, guarantees and investments – not gifts), in a time of intense financial stress, numerous outcomes are likely all of which would be deeply debilitating to the eocnomy and employment picture. For instance, the financial system functions on overnight and short term lending. When the Bear and then Lehman troubles surfaced, overnight lending was either unavailable or existed at a frighteningly high price. Also, these large banks have tremendous counterparty risk – it is not out of the realm of possibility to think that an AIG bankruptcy for instance would require 10′s if not hundreds of global banks to have to raise capital in a period where large amounts of capital are nonexistent (thus requiring government intervention). I have thought about the “Austrian” scenario a great deal lately – what if we did nothing? Unfortunately, this is not an option today. What is most important going forward is that regulations require any bank large enough to cause cracks system-wide, be regulated so that even a financial hurricane at one bank would be digested by the financial system reasonably well.
Bernanke’s video was actually very informative on 60 minutes: http://www.nakedcapitalism.com/2009/03/bernanke-on-60-minutes.html