Stop the Bailout!

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When facing
a major financial problem, it is not uncommon to face the temptation
to do something foolish at best or something evil at worst. Our
elected officials and un-elected monetary and financial authorities
are on the brink of doing both. Although the House of Representatives
defeated the initial proposed $700 billion bailout of the American
financial sector on Monday, Treasury Secretary Paulson vowed to
work with Congress to save the bailout plan.

The financial
bailout is a gigantic rip-off and must be stopped. All U.S. taxpayers
are on the verge of being looted to bail out financiers that made
a bunch of bad investments. This bailout is morally wrong and in
the long run will only harm the prospects of economic prosperity.

The economic
problem we are in is ultimately due to capital malinvestment encouraged
by government intervention in the money and banking system, including
a Federal Reserve that has engaged in irresponsible inflation via
credit expansion after the tech-stock bubble burst and after the
terrorist attacks of 9-11.

In order for
our economy to return to sound footing, the bad investments already
made must be liquidated. In other words, firms that cannot survive
financially must be allowed to go bankrupt. This is what happened
after the recession of 1921–22, which was sharper and deeper
than the recession of 1929–30. However, we don’t read of the
Great Depression of the 1920s because markets were allowed to adjust,
bad investments were liquidated, and the economy recovered in about
a year. Later, Presidents Hoover and then Roosevelt did not allow
this to happen in the 1930s and the agony was prolonged, turning
a recession into the Great Depression.

The same story
played out in Japan during the 1990s. There they had the roaring
1980s, much of which was financed with inflationary credit expansion.
The malinvestment chickens came home to roost in 1990, but the Japanese
government and the Bank of Japan did not allow the liquidation process
to take place and loads of bad debt were frozen in place on bank
balance sheets, so they experienced their own Great Depression of
the 1990s.

If a bailout
proposal manages to go through, the bad debt held by American banks
will be bought up by the state at artificially high prices and it
will be up to government bureaucrats to liquidate the bad debts
and sift the financial wheat from the chaff. There is no reason
in the world to think that a state bureaucrat can value assets more
correctly than entrepreneurs who are risking their own capital.
Remember, the government that now claims almost Gnostic wisdom regarding
asset values is the same government that created the mess to begin
with through intervention in the financial system.

Additionally,
any bailout adds to the moral hazard problem in financial markets
by verifying again what people only assumed might be the case before:
Commercial banks and investment houses can issue as many loans of
whatever dubious quality they want, because if things go bad, the
government will bail them out. So much for the free-enterprise system.

We
should also ask, just where is the $700,000,000,000 going to come
from to pay for this bailout? When the government spends money,
it has only three options for financing: The U.S. government would
either have to increase taxes to pay for the whole $700 billion
(which directly impinges on capital accumulation, worker productivity,
and standards of living), borrow the $700 billion (which takes that
much investment capital out of the hands of productive entrepreneurs
and foists the payment burden on our children), or inflate the money
supply by that amount (which will further raise prices, decrease
the purchasing power of the dollar, and set in motion another phase
of the business cycle). Or, as another option, the government could
do some combination of the three.

None of these
are good options. The best thing to do is let the firms that are
in trouble because of bad investments go bankrupt and allow the
market to adjust. There will be pain for sure, but the world will
not end, and no one would be robbed. Productive assets would find
their way into the hands of wiser entrepreneurs. The economy would
get back to a firmer foundation and on the way to building prosperity.

October
1, 2008

Dr. Shawn
Ritenour [send him mail]
is an associate professor of economics at Grove City College, contributor
to the Center for Vision & Values, and adjunct professor at
the Mises Institute in Auburn, AL.

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