A Personal Dilemma

We are in a dilemma this pm. Certainly we know that government intervention of any sort is suspect, that the foundation to government planning which Hayek so well illustrated means a limited group of individuals deciding the relative importance of different ends, thus the relative importance of different groups and persons. A rescue was fashioned for Bear but Lehman was abandoned; the world’s largest insurance company was acquired wholesale and now quite likely the mother-of-all-bailouts is just around the corner by the way of an RTC-like rescue of Wall Street firms in the main; that is, Paulson’s proposal to create a government-financed agency to take the most toxic assets (such as subprime mortgage backed securities) off the balance sheets of the US banking system. Together with today’s government’s blanket guarantee of the $3.4 trillion money market mutual funds the socialism of the financial sector appears to be proceeding apace.

This new entity would, unlike the RTC of the 80's, put taxpayers at risk. That is because the new entity would purchase illiquid assets at a discount from solvent institutions, then eventually try to sell them back to the market at a profit. Maybe so, maybe not. With the original RTC the government wasn’t exposed; the assets fell into its hand from failed institutions.

We have illustrated the perils, the addiction provided to abusers when gains are privatized but losses are socialized. Hey, why not? Yet today we are told that results of the cataclysmic sort will result if we don’t. Clearly in the case of some investment banks, certainly in the case of the auto makers their whining is just that. The fact I spent 25 years working for investment banks gives me a bit of a leg up over a salvage diver; still, when Bernanke warns Congress as he did today that without a bailout of a new order, we will have a financial meltdown, I just don’t know; I find it dangerous to doubt that. Can we make a case today as we have the past several that government intervention is always a bad thing? What if he’s right? In letting the system purge itself, our remedy all along, could it be that the heaves would prove fatal?

What startled us this week, specifically Wed evening is that the funding market for major world-wide institutions froze up. Not the bond market. Not the stock market. The O/N and short-term market, that which in the past provided liquidity for major operating institutions. This market provides funding for day-to-day operations; it has been around for 50 years. Normally the Royal Bk of Scotland (for purposed of illustration) is flush funds; these are lent out O/N or for short periods to Washington Mutual (for purposes of illustration) which is normally in need of short-term funds. If the RBS suddenly fears it won’t get it’s three day loan back, it will refuse to lend. That is what happened this week. But there was mass panic Thursday morning and the market locked up - nothing, only distrust. Even credit-worthy borrowers could not obtain their working capital. We agree that this would cause a rapid succession of failures; Paulson and Bernanke understood that.

If financial mastodons like AIG and the rest of these clowns are too large and too interconnected to fail yet not too smart to get themselves into situations where they need to be bailed out, then why let private firms engage in such activity in the first place? (I didn’t say that.)

Robert Craven