The Fairness of Financial Rescue

Brad DeLong says the undesirable act of bailing out those who helped to cause the financial crisis is justified by the greater good that came from this policy, but the public does not see it that way: 

The Fairness of Financial Rescue, by J. Bradford DeLong, Commentary, Project Syndicate: Perhaps the best way to view a financial crisis is to look at it as a collapse in the risk tolerance of investors in private financial markets. … [W]hen the risk tolerance of the market crashes, so do prices of risky financial assets. … This crash in prices of risky financial assets would not overly concern the rest of us were it not for the havoc that it has wrought on the price system… The price system is saying: shut down risky production activities and don’t undertake any new activities that might be risky.

But there aren’t enough safe, secure, and sound enterprises to absorb all the workers laid off from risky enterprises. … Ever since 1825, central banks’ standard response in such situations – except during the Great Depression of the 1930’s – has been the same: raise and support the prices of risky financial assets, and prevent financial markets from sending a signal to the real economy to shut down risky enterprises and eschew risky investments.

This response is understandably controversial, because it rewards those who … bear some responsibility for causing the crisis. But an effective rescue cannot be done any other way. A policy that leaves owners of risky financial assets impoverished is a policy that shuts down dynamism in the real economy.

The political problem can be finessed: as Don Kohn, a vice-chairman of the Federal Reserve, recently observed, teaching a few thousand feckless financiers not to over-speculate is much less important than securing the jobs of millions of Americans and tens of millions around the globe. Financial rescue operations that benefit even the unworthy can be accepted if they are seen as benefiting all – even if the unworthy gain more than their share of the benefits.

What cannot be accepted are financial rescue operations that benefit the unworthy and cause losses to other important groups – like taxpayers and wage earners. And that, unfortunately, is the perception held by many nowadays, particularly in the United States.

It is easy to see why.

When Vice Presidential candidate Jack Kemp attacked … the Clinton administration’s decision to bail out Mexico … during the 1994-1995 financial crisis, Gore responded that America made $1.5 billion on the deal.

Similarly, Clinton’s treasury secretary, Robert Rubin, and IMF Managing Director Michel Camdessus were attacked for committing public money to bail out New York banks that had loaned to feckless East Asians in 1997-1998. They responded that they had not rescued the truly bad speculative actor, Russia; that they had “bailed in,” not bailed out, the New York banks, by requiring them to cough up additional money to support South Korea’s economy; and that everyone had benefited massively, because a global recession was avoided.

Now, however, the US government can say none of these things. Officials cannot say that a global recession has been avoided; that they “bailed in” the banks; that – with the exception of Lehman Brothers and Bear Stearns – they forced the bad speculative actors into bankruptcy; or that the government made money on the deal.

It is still true that the banking-sector policies that were undertaken were good – or at least better than doing nothing. But the certainty that matters would have been much worse under a hands-off approach to the financial sector, à la Republican Treasury Secretary Andrew Mellon in 1930-1931, is not concrete enough to alter public perceptions. What is concrete enough are soaring bankers’ bonuses and a real economy that continues to shed jobs.

Originally published at Economist’s View and reproduced here with the author’s permission.
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2 Responses to "The Fairness of Financial Rescue"

  1. wdm223   December 31, 2009 at 7:55 am

    This is ridiculous:Give the alcoholic with DT’s another drink.Is DeLong an economist or apologist/propagandist?The economic vital signs of the US, continue to deteriorate-CAD (if and when US economy recovers it will deteriorate-an arithmetic necessity), fiscal balance, fragility of banking system, corruption of the elite, employment…solvency of US is an issue: add up US debt, GSE debt, debt of financial system with implied guarantee and off-balance sheet liabilities of the SS system and medicare and you get to bankrupt banana republic numbers far in excess of 200% of GDP.His assumption that it could have been worse is not supported by fact or theory: “if we had not transferred massive public wealth to the private sector we would have had a repeat of the 30’s” is a scare tactic like “we don’t know there aren’t weapons of mass destruction in Iraq so we must invade”…this would not pass a logic 101 course.Massive government borrowings, support of insolvent banks that proceed to gamble for redemption via the carry trade and looting via crony capitalism, unsustainable fiscal and CAD deficits are the ways of Argentina-the ways of DeLong, the ways of postponing disaster to the not too distant future….just more voodoo economics.

  2. decouple   January 1, 2010 at 2:25 pm

    The rest of the economy does not have the capacity to absorb thousands of investment bankers who’d lose their jobs. But they made so much money over the past few years they should be able to get by for a while, unless they’ve already spent it all.No more bailouts. Kill the zombie banks.