An often repeated saying is that the definition of insanity is to continue to do the same things and to expect different results. I know we have made this point several times here, but it is worth pointing out until it sinks in everywhere: We have a problem caused by easy credit and the solution our leaders have offered is more easy credit; we have a problem of “too large to fail” institutions and our leaders have encouraged even greater consolidation as a solution.
Now the debate is over nationalization of banks. Paul Krugman put it well in a recent column when he compared the government making a decision to nationalize underperforming banks to the Claude Rains line in Casablanca, “I am shocked shocked at the miserable state of their balance sheets.”
His point was that once the proposed stress test on these banks are complete, those that don’t cut the mustard should be nationalized, fixed and then sold as the FDIC does on a regular basis with smaller non-performing banks.
We know that the Fed and or the Treasury have been directly helping to prop up these banks since the summer of 2007 but in another sense they have been doing it longer. Large financial institutions have to a large extent been dictating regulatory policy for many years. It seems that Goldman Sachs through former high ranking executives has had a permanent seat in government over numerous administrations. To think that the “too big to fail” nature of these top financial institutions was not worked into their risk models would be somewhat naïve.
It has been a “soft nationalization” of risk that has gone on before the TARP and before opening up the Fed’s borrowing window to investment banks and broker dealers and all of the special auction facilities the Fed has created to help these institutions flush out their toxic assets.
Many market observers have cautioned that what is being created is a system where risk is socialized while rewards are privatized. The question of moral hazard is solemnly discussed. But the point that is being missed is that the whole financial crisis is the result of moral hazard and the process where these large institutions have been able to socialize their risk while keeping their profits is one that has occurred over years not months.
The beauty of capitalism isn’t necessarily the absence of government from all private enterprise but that those who take on risk should benefit from the rewards borne from that risk.
So if taxpayer money is used to save institutions, the taxpayers must get a portion of the rewards once those institutions are back on their feet. Yes it is best if government does not have a direct say in private enterprise—other than providing an appropriate regulatory structure—but to act as if the issue of nationalization and government bailouts is one that was created in September 2008 is to ignore the soft nationalization of risk that has gone on for a much longer timeframe.
When at last the crisis is over there should be lessons ingrained at large financial institutions, government institutions and the public at large regarding free markets and inviting government intervention of all stripes.
A few months ago we wrote about a group of protesters angry over the University of Chicago honoring the late legendary economist and Nobel laureate Milton Friedman. The protesters argued that Friedman’s free markets mantra is partially responsible for the current mess our economy is in. At the time we noted, “Despite the best efforts of Friedman, his free market philosophy has never been close to being adopted in total. And of late, a system of influence peddling where special interests can carve out their own rules even utilizing the largesse of government when necessary to support their initiatives, has taken root.”
We pointed out how Friedman himself had warned about this in a 1999 policy speech titled, “The Business Community’s Suicidal Impulse.”
Friedman stated, “At the end of World War II commercial banking accounted for roughly half of the capital market. Today it accounts for about one-fifth. Why has it deteriorated? Why is the international financial market in London, not in New York? The answer is the long-term effect of the of the banking industry’s insistence on special government favors.”
While he was not addressing the issues facing us today, the larger point is you can’t speak free market economics out of one side of your mouth, while soliciting government favors from the other side and expect to have it both ways.
Tags: Fed, Friedman, Soft nationalization, TARP, Treasury
