I kicked off the new year by finishing up Financing Failure by Vern McKinley (2011). The author runs through all the financial bailouts in the U.S. over the past century, taking a negative view and arguing that history really does repeat itself.
The common theme is that politicians cannot let anything bad happen on their watch. Accordingly, in times of panic and without a full understanding of the facts, they implement huge bailouts, rationalized with fear mongering and by suggestions of terrible knock-on effects if nothing is done. To that point, McKinley spends a great deal of time parsing through and serving up the words of the relevant players (i.e., Bernanke, Paulson, Geithner, Treasury, Fed, FDIC) and establishes that their blustering words of imminent peril are never backed up with compelling data. Add to that, there is an inconsistency in why someone is bailed out – the explanation for why Lehman failed but it was important to support AIG and Bear Stearns is still hard to understand. Sure, a false distinction is made between liquidity weakness and capital weakness, but it is not very convincing. All of which adds to the uncertainty that proves to be the real problem.
McKinley also examines the idea of moral hazard – how the bailouts and protections instituted in the aftermath of a panic actually encourage more reckless behavior going forward. Whether it is higher levels of deposit insurance or letting an insolvent institution live on, the risk-takers see little incentive to dial back their behavior. As a case study of how bailouts do not have the intended effect, the author follows the story of Continental Illinois Bank and Trust Company. It was bailed out in the ‘30s, again in the ‘80s, and was eventually subsumed by Bank of America, which everyone knows was bailed out in the 2000s.
The upshot is that bankruptcy is the logical conclusion for a poorly-run company. Thus, according to McKinley, the government does have a role – to wind down these failing institutions. Sadly, that obligation is often ignored. Instead, they create new regulators (surprise, surprise, usually it’s the same folks who missed the original crisis, just with a new title), new laws, and new bureaucracies. The answer is always more government. And the outcome is always another crisis down the road.
So, to quote the author, quoting Ecclesiastes: “What has will be again, what has been done will be done again; there is nothing new under the sun”
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This post marks number 300 for the blog. Thanks to all who have stuck around.
