Wallstreet Bailouts: Business as Usual
From USA Today
Economics professor Allan Meltzer once said, “Capitalism without failure is like religion without sin.”
President Obama’s proposed reform of Wall Street calls for creating a list of large financial firms (“Tier 1 financial holding companies”) that will be officially designated as “too big to fail.” They will, in short, be guaranteed rescue by taxpayers if they get into financial difficulty. This will be disastrous because it will encourage further speculation and saddle taxpayers with the cost of cleaning up future trillion-dollar financial messes.
The simple fact is that this sort of big government coddling is what got us into this mess in the first place. Wall Street is not a bastion of free-market laissez faire capitalism. Consider this simple question: How many times have the big firms like Goldman Sachs, J.P. Morgan, etc. been bailed out in the past 15 years? The big firms on Wall Street have been rescued from their profligate investments half a dozen times since 1994. And that propelled us to near collapse in 2008.
For example, in 1995 the Clinton administration used taxpayer money to extend a $20 billion line of credit to rescue Goldman Sachs and others from speculative, high-risk Mexican government bonds they obtained through arbitrage. (Arbitrage means borrowing money to leverage your investment.) In the end, this bailout saw to it that the speculators not only got their money back they also received a healthy profit.
Getting away with ‘murder’
When financial crises engulfed Asia a few years later, investment houses J.P. Morgan and Citigroup, among others, were facing billions of dollars in losses because of risky bets on financial derivatives. As then-Treasury Secretary Robert Rubin recounts in his memoirs, many of the investment houses were so reckless they didn’t even know what their exposure was: “It took them a week to find out.” Again, the Clinton administration rescued the speculators, bailing them out with healthy profits intact. As Paul Blustein of The Washington Post put it in his masterful history of the global finance crisis, The Chastening, “The international banks got away with murder.”
Investment houses in the mid-1990s also poured billions into Russian GKO bonds — high-risk bonds paid in rubles — again often using arbitrage. Everyone knew Russia was unstable. Again, Washington tried to bail them out, including a $22.6 billion international package, with U.S. taxpayers on the hook for almost a third.
Soon there were jokes about “Government Sachs” being the big firm in world finance.
When the hedge fund Long-Term Capital Management threatened to go under in 1998, again Washington stepped in to help organize a bailout. With help from the federal government, all the big firms that had invested in LTCM recovered their investments.
In 1998, the Clinton administration bailed out J.P. Morgan, Merrill Lynch and Citigroup from speculative investments and loans in Brazil, which had a history of defaulting on loans. The administration tapped a special U.S. Treasury fund to finance it because Congress would not go along, arguing that in each and every case, failure to act would result in “financial instability.” But what the administration really did was lay the groundwork for even more speculation, regardless of whether these firms had to pay back the government.
A permanent arrangement
To its credit, the Bush administration largely ended this practice. In the words of Blustein, Bush refused “to follow the Clinton example of using U.S. taxpayer dollars to fatten up the rescue packages and letting the brokerage firms get out with their profits intact.”
One can argue that the fall 2008 crisis was so widespread and systemic that emergency action was necessary. But what President Obama is doing is creating a permanent arrangement between Washington and Wall Street. It is downright dangerous, the equivalent of bailing someone with a DUI charge out of jail, giving him the keys to the car, tossing a six-pack in the back seat, and telling him everything will be OK. Nothing good can come of it.
Bailing out speculators breeds more speculation. In the world of finance they call it “moral hazard,” best defined perhaps by the British philosopher Herbert Spencer who once said, “The ultimate result of shielding men from the effects of folly is to fill the world with fools.” Obama’s proposed list of firms “too big to fail” will simply create more foolishness on Wall Street.
There is a huge distinction between being pro-business and pro-free market. The Obama administration is being pro-business because it is proposing to prop up individual firms at taxpayer expense. What it should be doing is being pro-free market, which means encouraging greater competition and letting fools fail.
Greed and speculation are a fact of life in human nature and on Wall Street. Can we really blame Wall Street speculation if we create a system where there is a limited downside? The best deterrent to speculation is to make sure that speculators lose their shirts when they bet wrong.
The greedy don’t like to lose their money any more than the rest of us. Obama’s plans will permanently create a system for the big Wall Street firms in which they will enjoy state capitalism in which the profits are privatized and losses are socialized. The end result will get religion without sin, risk-taking without constraint.
Peter Schweizer is a research fellow at the Hoover Institution at Stanford University and was a speech-writing consultant to the Bush White House in 2008-09. He is author of Architects of Ruin: How Big Government Liberals Wrecked the Global Economy And How They Will Do It Again If No One Stops Them.
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