Friday, February 12, 2010

Again, The Unwarranted Assumption

With the Greece bailout on the horizon, it is useful to look back to 2008 and ask what would have happened if the US Treasury and the Federal Reserve had not bailed anyone out...anyone. Starting with Bear Stearns, simply let them go bankrupt and continue with Fannie, Freddie, AIG, Lehman and even mighty Goldman Sachs and Morgan Stanley, if it came to that.

The assumption is usually made that the some cataclysmic disaster would have occurred. Why make that assumption? What is most likely to have occurred is that bondholders would have shared in the losses along with stock holders and that these businesses would have been reorganized in some more reasonable fashion. The bailouts that actually took place did not prevent the worst recession since the 1930s from taking place. Why assume that things would have been worse?

You have to wonder why the burden of proof is not on those who supported the bailouts. These unprecedented, undemocratic, probably unconstitutional actions taken by the US government in 2008 have shattered the faith in the free market and are hastening the bankruptcy of the federal treasury. How can one comfortably assume that simply letting bad actors suffer the fate of their mistakes would have been worse.

Bondholders who willing lent money to Bear Stearns, Fannie, Freddie, AIG should have suffered major losses for being foolish enough to lend to over-levered institutions that would not, in the long run, succeed. Instead taxpayers suffered the losses and bondholders learned nothing from their cupidity. Why is that a better outcome?

Now, the Euro community is facing the same dilemma. Should they bailout Greece. If they bailout Greece, what is the message for other Euro nations living far beyond their means -- Spain, Portugal, Italy? Who will bailout Germany after they bailout these countries? Who will bailout the UK? Who will bailout the US?

Bailouts are "easy think." They make the next five minutes feel good. But, in the long run, bailouts simply put off the day of reckoning for institutions that are run in stupid ways. It rewards non-thinking bondholders. It paralyzes the economy, by turning off the credit spigot to companies that are doing the right thing.

Why assume that the bankruptcy of Greece is the worst thing that could happen? It's not. The worst thing that could happen is that EU nations cobble together some type of bailout and kick the can down the road. Greece will continue to spend like a drunken sailor and, within time, the contagion of bad fiscal behavior will spread.

Bankruptcy is a good thing, not a bad thing. It is the only way that markets can discipline stupid companies and stupid governments. If you don't permit the profligate to go bankrupt, then, eventually, all will be bankrupt.