Law & Justice: September 2008 Archives
Despite the announcement on Sunday that a bailout deal had been reached, I was pleased to see yesterday that the deal fell through. Good. The markets were down because people realized that the government wasn't about to pay $1 for assets that are probably only worth 50 cents. That's bad for the people who own those assets, but good for the taxpayers who were about to buy them at inflated prices.
Harvard professor Jeffrey A. Miron has written the best prescription that I've seen so far: the solution is bankruptcy, not bailout. I've been saying the exact same thing for weeks. Maybe I should be an economics professor?
The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.
In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.
Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.
Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.
Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.
Just go read the whole thing. It's concise and exactly right on every point.
Good morning, fellow AIG shareholders! If you're an American, you now own a chunk of the country's "largest" insurance company... not counting the debt obligations that make it insolvent.
The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.
The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)
First, I say let these companies fail. Oh, I know, it'll be the end of the world! Really? One day after Lehman Brothers went bust Barclays wants to buy them. The financial system won't go poof if these companies fail... but a lot of our elites will be out on the street.
Second, that's exactly what should happen. Here's my suggestion for a bailout law: if your company is SO important that we have to bail you out to avoid a total collapse of the world economy (*cough*), then when we do so the top 1% of all earners go to jail. The CEOs get life sentences, and we can work our way down from there.
