Wednesday, September 17, 2008

Bailouts - past and present

I can just see the argument. Congress is upset that good American taxpayer money is going to rebuild Germany.

The conservative press argue about Moral Hazard. If countries elect dictators and then try to take the world over by force and exterminate minority races there is no loss to them if you rebuild. We shouldn’t rebuild them – better leave them a smouldering ruin and lay waste Europe because otherwise we would have moral hazard.

And so the Marshall Plan died.

Fortunately it didn’t happen that way. Europe was rebuilt and the world wound up a safer place.

And so I make a plea to the world. Please dump this bailouts are a bad idea thing.

Some bailouts turn out to have been a very good idea – some are suspect. The bailout of Mexico didn’t wind up costing the taxpayer very much – and was better than the alternative – a complete social debacle on a country that last I looked shared a long border with the United States.

The Norwegian bank bail-out of 1992 cost the shareholders a pretty-penny (they lost everything). But the Norwegian economy bounced quite rapidly and the Government actually made a profit.

By contrast the first bailout of S&Ls in the early 80s set up a much larger debacle in the late 1980s (see my history of US Finance paper).

What is really required is not a blanket rule against bailouts – or a blanket rule for them – but – what is in my favourite phrase of the day “constructive ambiguity”. Oh, and sacking the management of said institution for cause and denying all the golden handshakes etc. Suing Dick Fuld would be a start too.

John Hempton


Max said...

That was pretty lame.

Truman and Marshall were both veterans of WWI. They learned from that experience.

At the end of WWI, the Europeans basically told the Americans, "You can run along now. The adults are in charge here."

Twenty years later the "adults" were at each others throats again. After this war, the Americans stayed and occupied Europe, former allies and former enemies alike. Pax Americana.

Anonymous said...

history of us finance link points to marshall plan

Anonymous said...

Thank you for being someone who "gets it."

John Hempton said...

Max - I am well aware of history. The post WW1 period was squandered. The best book ever written on the causes of ww2 was written just after ww1. - its called the economic consequences of the peace.

The mark of a super-conservative historian is that they call that book destructive rather than just anticipatory. There are a few histories like that such as Paul Johnson's right wing classic.

Anyway I just wanted to make sure that ideology didn't get in the way of analysis.

I got another post to write on constructive ambiguity...


dWj said...

In re your observation about sacking management, it's worth noting that, while the Marshall plan went forward, it did so after hanging a few Nazis first.

Truth-and-reconciliation, at least for all but the very most culpable, has a great deal of history to recommend it for the very biggest evils. Allowing consequences to fall on those who sowed them, though, is a better idea for the quotidian failures. Running a major financial institution the way Lehman and AIG have been run is better than Naziism. I don't know whether it's exactly quotidian, but I think I'd put it more in that camp.

In the case of Naziism and apartheid, there was no likely incentive value to punishing, and you could treat what were otherwise sunk costs as such without worrying about the time-consistency problem where people or institutions in the future expect you to treat such actions as sunk costs. The reason for bailouts now is not that we need to let bye-gones be bye-gones, allow the institutions to pick themselves up, dust themselves off, and go about their business, and pay no heed to moral hazard -- it's that any reduction in moral hazard and even cost to the innocent taxpayer could well come down as a bargain compared to what might well be the alternative for that very innocent taxpayer. Indeed, if any of these companies was going down all by itself, and the rest of the system looked great, nobody would even be thinking about a bailout. As things are, purely from the standpoint of the innocent, it may be that the choice is between bad and worse, and that bad leaves the guilty better off than they deserve. While this ultimately was the case for foregoing "justice" after WWII, today we get there less by thinking about the guilty than the innocent.

egghat said...

Wow! Brilliant post!

Putting todays Bailouts and the Marshall plan into perspective really tells you something new.

Bailouts done right (like the AIG bailout that's essentially a Private Equity deal) is the worst you can do. Bu the only other option is doing nothing, which is even worse.

Btw. I love this blog!

Anonymous said...

I saw a story this morning saying KDB had agreed to invest c.$5bn in LEH in return for a controlling stake. Management balked at ceding control and so turned down the deal. Suing The Big Swinging Dick Fuld seems like a good idea indeed.

Michael said...

Great work with your History of U.S. finance.

Ron Paul recently talked about moral hazard as well regarding bailouts. Just posted that at my own


Peggy McGilligan said...

When Bill Clinton eased banking restrictions in California, he also dished out $8-billion dollars for "community redevelopment loans.” Of course, the money would never get paid back. Undoing regulations sets a precedent, as does "comping" real estate. With the influx of cheap capital, properties already overvalued at $125,000 inflated to $525,000. Enter, "creative financing.” When the schemes fell through, as is their wont whenever 30-million Mexican nationals buy inflated properties and default, it left bankers around the world in the lurch (see global economy). Never mind that the aforementioned demographic is the new face of the Democratic Party; because of rampant “creativity” and subjective prices, Congress simply cannot determine the worth of the financial instruments. It’s a $90-billion bailout at best. But if you want to thank someone, thank Hillary Clinton. She knew all along who’d get the loan giveaways; she knew whose votes she’d buy. It was a blank check. So, why should hardworking Americans bail the housing bubble? Let the Dems pickup after themselves, let those 18-million cracks pass the hat:

ssss said...

Michel Telo it's a nice article to read.

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