Posted by: Jeff | August 25, 2009

The Bailouts Were Probably a Good Idea

Tyler Cowen, the libertarian economist who blogs at Marginal Revolution, has tentatively come to the conclusion which provides the title above. (Hat tip to Megan McArdle.)

Without the bailouts we would have had many more failed banks, very strong deflationary pressures, a stronger seize-up in credit markets than what we had, and a climate of sheer political and economic panic, leading to greater pressures for bad state interventions than what we now see.

I assume by “bad state interventions,” Cowen means bank nationalization. Obviously, I wouldn’t consider nationalization nearly as objectionable as he would (I’m not a libertarian, after all) but I do think the breezy confidence with which a lot people on the left advocated for that approach was short sighted.

We’ve nationalized banks before, for example in the savings and loan crisis in the 80s, but my understanding is that the sheer amount of banking infrastructure the government would have needed to take over this time out would have been historically unprecedented. Even if you don’t have any ideological objections to government officials taking over banks (as I don’t) there’s still a whole lot that could go wrong in that scenario simply as a matter of practical complexity. Nor is it clear that nationalization would have been any cheaper, given that the government would have been taking responsibility for the banks’ rather toxic portfolios.

And when we nationalized in the 80s, the government took over only a portion of the financial system. It unwound the banks’ assets, got them back on a sound footing, and then sold them back to the portions of the private financial market which remained healthy. This time out, it was the whole bloody system that was coming apart at the seams. Even assuming the government would have been able to put that many banks back together again, who would have been left on the private markets with the wherewithal to buy them back?

So I think Cowen’s right to challenge libertarians unhappy with the bailouts to present a reasonable counterfactual, and I’d say the same obligation falls to the liberals and leftists who remain opposed to the bailouts. (Opposed, obviously, for different reasons than libertarians and conservatives.)

In the end, there were probably three choices, broadly speaking. Nationalize the banks, which would have been a horrendous, complicated, risky mess. Bailout the financial industry, which was also risky, grossly unfair, and a bit of a mess, but seems to have worked. Or do nothing, and let the market sort itself out. Which it would have done, eventually. But that “sorting out” would have come with far, far greater levels of misery and suffering for the average American than we wound up enduring.

I suppose a leftist anti-bailout argument could be made that if we had done nothing, the ensuing economic collapse would have produced the necessary political will to radically transform the American economic order in a more progressive direction. (A la the transformation of the New Deal.) Quite possibly so. But that seems a horribly perverse way to motivate reform.

Fact is, we didn’t just “give away” the bailout money to the banks and the Wall Street tycoons. We all got something in return for that $800 billion. Conservatives, libertarians and the powers that be got to avoid a populist leftwing economic revolt. Everybody else got to avoid what might well have been another Great Depression.

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