Evaluating the bailout

on Aug 25 in Financial Market, Politics tagged by Trevor Hicks

Tyler Cowen challenges those of us with a libertarian bent to consider that the US government is making profits on the TARP and bank bailouts.  He think we should either admit the bailout was the right move or come up with a plausible counterfactual about how things would have been better.

If you are a libertarian, is not our current course more favorable for liberty than would have been a repeat of 1929-1931?  If not, I would be curious to hear your counterfactual version of how matters would have proceeded, without the financial bailouts.  Is it that you think the regional banks would have raised the financing to pick up the entire bag and keep the banking system afloat?  Or is it that natural market forces would have somehow avoided a wrenching surprise deflation?  Or do you think the authorities for some reason would have not nationalized the major banks?  Please let us know.

It’s a fair point, if the government ultimately profits (or doesn’t take too huge of a loss) on TARP and the other bailouts then it would justify the rational for creating the program, that the banks were mostly sound enterprises being squeezed by short term cash flow problems. It would mean the assets purchased by the government had more value than assigned in the marketplace, which is why there are profits. If the government had not acted to rescue the banks, the liquidity crisis would have then destroyed the value still inherent in the banking enterprises. So not only did the government profit, but the country as a whole did by preserving the value of these banks.

What we have to also assess is the long term cost of the bailouts. The statists argue that the long term effects should be positive, that tighter government control over the banks, if not necessarily wealth enhancing for the country, enhances the well being of the nation as a whole by reducing volatility from the sector and eliminating a major source of wealth inequality from the astronomical pay packages that are common on Wall Street. I worry about the subjugation of a major industry to political control (or is it the other way around, are the bankers now running the government?) I’ve worked in the oil industry my entire adult life and I see firsthand the negative impact on productivity and wealth when an industry is controlled by the politicians. Decisions become based on connections, favors, elections and self-dealing rather than profit-maximizing risk-based cost-benefit analysis. The less control our politicians have over any industry generally the better.

We can measure the short term effects in dollars, but not all of the long term effects, so without a common denominator it becomes impossible to write a single test for whether the bailouts were worth it. The other problem is that the question explicitly deals in counterfactuals, Tyler claims with good reason that without TARP that Pelosi & co. would have come up with something far, far worse to “fix” the problem in response to a highly anxious electorate. Can we pin the automotive bailout on TARP as well? Would Bush have started that process without having saved his Wall Street buddies first? The automotive bailouts I think are doomed to massive losses, GM alone cost more than its market cap ever reached. I think it’s pretty magical thinking to hope that that deal will be profitable.

One last issue, it’s awfully early to say that TARP is or will be profitable. The strongest institutions best able to repay their loans like Goldman Sachs have been nicely profitable as you would expect. Let’s wait another 12 or so months for ‘normal’ economic times and see how Citi and AIG turn out before calling TARP profitable.

All this to hedge my answer and explain why I fail to be definitive. But I will go along with Tyler and say that yes, if TARP turns a profit (or not too huge a loss) then I will agree that it probably was the least terrible thing for Bernanke/Paulson/Bush to do in the situation. If TARP also actually ends with all the accumulated assets in the Fed and Treasury returned to the private sector in say, a total of 36 months then I’ll admit I was definitely wrong to so strongly oppose it.