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Source link: http://archive.mises.org/8636/the-rescue-package-will-delay-recovery/

The Rescue Package Will Delay Recovery

September 29, 2008 by

It is true that the financial system must be rescued; it must be rescued from the institutions holding bad debt that are currently draining capital while waiting for a bailout and adding little in return. It is they that are preventing wealth-generating activities in the financial sector and the other parts of the economy. They must not be rescued, lest the debt overhang continue and delay recovery. FULL ARTICLE

{ 17 comments }

fundamentalist September 29, 2008 at 8:53 am

Shostak: “More money cannot generate real wealth.”

This is the lesson that Americans simply cannot get their heads around. If they could, they could see the folly of the bail out. But if they could, they would be Austrian, wouldn’t they? This may be the most important economics lesson anyone can learn. Every high school in the country should require one class in the Austrian description of money.

I visited the Tulsa State Fair yesterday and found a T-shirt vendor with one that had a picture of Geronimo with the caption “Of course you can trust the government. Just ask an Indian.”

fundamentalist September 29, 2008 at 8:54 am

Shostak: “More money cannot generate real wealth.”

This is the lesson that Americans simply cannot get their heads around. If they could, they could see the folly of the bail out. But if they could, they would be Austrian, wouldn’t they? This may be the most important economics lesson anyone can learn. Every high school in the country should require one class in the Austrian description of money.

I visited the Tulsa State Fair yesterday and found a T-shirt vendor with one that had a picture of Geronimo with the caption “Of course you can trust the government. Just ask an Indian.”

Adam September 29, 2008 at 8:57 am

If loose monetry policy created the bubble and then a tightening of that policy created the contraction of the credit market, was the appropriate level some where in-between? Where does it go from here?

Mark September 29, 2008 at 9:36 am

Remember: government is not a wealth generator; it can only take resources from A and give them to B.

Not if you believe in liberal creationism. You can no more convince a Keynesian that economics is an emergent process because of the paradoxical implication of the Confirmation Bias, than you can convince a fundie that those neurons vying for serotnin and dopamine have a purpose.

Let’s face it. We’re heading to Pinochet moment.

Jacob Steelman September 29, 2008 at 9:45 am

The bailout by the US Treasury (by the US taxpayer) and the Federal Reserve (by the holders of US dollars and US dollar denominated assets through inflation) is a giant bankruptcy. To the extent that it allows financial firms to rid themselves of bad deals and continue in business it rewards inefficient and less competent bankers and thereby punishes efficient and competent bankers. The efficient bankers are forced to compete with the inefficient bankers who have had a windfall from the US government. The sub-prime problem and CDS (credit default swaps) problem are really problems of certain investors such as AIG and Bear Stearns who assumed incorrectly that the Fed would continue inflating and that housing prices would continue forever. JP Morgan, who created the CDS in order to hedge its loan portfolio in the early 1990s, did not have a problem and in fact bought Bear Stearns and now Washington Mutual. Why? As creator of the CDS JP Morgan understood the risk of this financial product and were out of the market. Others who copied the JP Morgan model of using CDS to hedge their loans apparently failed to appreciate the risk and also wrongly assumed the continuation of inflation by the Fed. To some degree there is also moral hazard at work here as well especially with AIG who assumed correctly that the Fed would not let it fail for failure would bring about the collapse of a number of other financial institutions who failed to appreciate the limits which one company has to insure all the high risk sub-prime investments undertaken by the financial community. The government should not protect businessmen and women from the consequences of their actions – malinvestments should not be rewarded by the government. It is why the Soviet Union collapsed – systemic malinvestments and insulation from the rigors of the market place as a result of government dominated command and control society and economy created a large inefficient economic system which eventually collapsed. Ironically the Bush administration preachers freedom but in fact is pursuing the largest shift to a command and control economy since FDR.

Dither September 29, 2008 at 9:56 am

This is a wonderful explanation of what happened, and clear enough that I can pass it along to friends who are not well versed in economics and finance. Thank you, Mr. Shostak!

Michael A. Clem September 29, 2008 at 9:57 am

If loose monetry policy created the bubble and then a tightening of that policy created the contraction of the credit market, was the appropriate level some where in-between?
Not necessarily. Any tightening may have helped cause the contraction, but it still may not be enough to bring it back to the free market rate. The only way to find the right balance between supply and demand of credit is to the let the market find it. The market can handle the ever-changing circumstances much faster and more reliably than the Fed, or any individual or organization can, because of the nature of the information involved.
And I wasn’t planning to go to the Tulsa State Fair this year, Fundamentalist. How is it?

Curt Howland September 29, 2008 at 10:01 am

So far, the biggest mistake I see people making is by not addressing the most important fact that this article points out right at the beginning:

This Bailout has nothing to do with the financial instruments themselves. It has nothing what so ever to do with rescuing individuals who cannot pay their loans.

This Bailout is to bailout the companies that hold those loans. This Bailout is making sure that mistakes don’t have repercussions, that bad business practices are saved, that political contributors and insiders are rescued from the results of their own actions.

Adam, Mises made very clear that there is no “middle ground”. The only stable position is that of complete removal of the state from the supply of money.

No matter how much it may seem to be a line, from “none” to “complete”, there is no actual line. With the first regulation, the government gains control over their own finances. That’s it.

Just like being “a little bit pregnant”.

It’s a difficult leap, I know. I am the victim of 12 years of government schooling, it took time to realize that everything the state touches turns to poop. Everything! I was about to say “especially money”, but then realized that money is just one more thing. There’s nothing special about “money” that the government does worse, or better, than anything else.

Robert Nathan September 29, 2008 at 10:34 am

Those of us that were in Texas in the mid eighties will recall the “Great Southwest Recession”. Since it was a regional phenomenon, it was not the national priority that the poli-eadia has made of the current Wall Street problem.

Never the less, there was a real estate bust, followed by numerous bank failures. There is scarcely a bank in Texas that has the same name as it did prior to about 1981. And many of these institutions, on a regional basis, were “too big to fail”. But fail they did with little notice from the Fed or the Treasury.

Is this current event so much bigger, or was I just too close to the Southwest Recession?

With little Federal involvement, we did in short order eventually recover. There is nearly as much growth today as there was prior to 1981. Perhaps this is the sign of another regional bubble?

fundamentalist September 29, 2008 at 10:35 am

Adam : “If loose monetry policy created the bubble and then a tightening of that policy created the contraction of the credit market, was the appropriate level some where in-between?”

As Shostak writes later in the article, the collapse would have come eventually, even if the Fed had not raised interest rates. The Fed’s action just sped up the process. Had the Fed not raised rates when it did, price inflation would have occurred sooner and competition for new loans would have raised rates anyway. Hayek has a good explanation of this in his “Investment that Raises the Demand for Capital.”

Michael A. Clem: “And I wasn’t planning to go to the Tulsa State Fair this year, Fundamentalist. How is it?”

Timeless. I doesn’t seem to have changed any in the past 30 years. There does seem to be more fried foods. I saw deep fried cheesecake to go with the deep fried Oreos and alligator on a stick.

Enjoy Every Sandwich September 29, 2008 at 11:13 am

I know that I’m terribly cynical when it comes to the state, but I can’t help but wonder if a delay in the recovery wouldn’t suit some folks in the political class just fine. For them, a “crisis” is an opportunity to expand the state.

For example, an editorial in today’s Washington Post by Lawrence Summers says that the current situation is a good time for more “investment” in such areas as health care.

For those who think that the Soviet Union had the right idea but just “didn’t do it right”, these are glorious days.

Eric September 29, 2008 at 2:01 pm

Watching DC and the FED is the closest we will come to witnessing the brilliance of human witch burning from earlier centuries.

I suppose there must have been some “Austrian Witchcraft Theorists” back then that were trying to teach people that going back to pre-Abrahamic human sacrifice was not going to make the witch problem go away.

Actually, I think a closer analogy might be that Americans are a cargo cult. We believe that pictures of dead presidents (and one central banker) will bring us wealth. After all, we’ve seen this happen, just look at those lucky people on let’s make a deal. All those suitcases full of cash. It has to be a good deal.

But if DC just sits there and does nothing, surely our modern day witch problems will get even worse. So, on with the burnings. At least the FED and DC will be seen to be doing something.

Andrew Dorfman, MD September 29, 2008 at 2:06 pm

Dr. Schostak,

I agree with the fundamentals of your helpful and explanatory analysis.

I want to also point out that these following statements seem highly premature to me:

“The market’s ability to make swift adjustments without much drama was vividly illustrated only a few weeks ago when the very large investment bank, Lehman Brothers, was allowed to go belly up. The world did not come to an end. Instead, this was a healthy development. A money loser was eliminated from the market. This freed up resources to promote growth.

“One could have made the case that when Lehman was on the brink it was too big to fail — assets of $639 billion and employing over 26,000 people. Yet in a few days the market, once allowed to do the job, reallocated the good pieces of Lehman to various buyers and the bad parts have vanished. It was poetry.”

There is truth in the principles you stand upon, but the patient, Mr. Lehman, has not yet been burried and the effects and extent of his scourge are still to be measured.

A recent article, I believe in the FT’s, suggested it would take perhaps two years to unwind and settle the enormous portions of the grossly under-capitalized “securities” of Lehman’s still-standing trades and obligations. So I do not see the issue as gone, settled, or, merely poetic, though I remain still and always moved by great poems.

Thank you for all of your comments to date. I generally find them of applicable and direct use.

I think my comments are an attempt to remind us all to avoid any hints of hubris in this time of historic illustration and decimation, which will effect many living persons who do not understand real economics, and instead experience only a complex financial maze of corrupted motives.

Warmly,

Andrew

Matt September 29, 2008 at 4:59 pm

“The Fed’s loose policies are the crux of the problem.”

Close but not true. The crux of the problem is the creation of the FED. This scam has been with us now for decades..in which there are only two possible winners. The Congress and its endless deficit spending and the Banks with their Fractional Reserve Banking i.e. charging interest on money lent but don’t have. Can the FED and Congress prevent the correction again? Maybe, but then the next Recession/Depression will surly burry the FED.

John Brock October 1, 2008 at 2:23 pm

I submit that it will not only delay recovery, it will make recovery exponentially more difficult and set a precedent for future law makers to act upon which will not be in the best interest of the nation’s citizenry.

Moreover, it will weaken our nation’s committment to free market principles thus further deteriorating the influence we have on global economics and politics (if one can separate the two) amongst our enemies and allies; while simultaneously beating down our ability to promote democracy.

Deborah October 4, 2008 at 11:06 am

I appreciate and agree with a lot of the comments here as far as the banks are concerned, but what about the individuals who are holders of issues from these banks? For example, in HongKong, holders of Lehman Brothers’ minibonds stand to lose their life savings due to the bankruptcy. Another example is the 90-year old woman who shot herself because her home was foreclosed. What is the solution for them? I don’t believe that the answer is simply to sit back and criticize them for making bad decisions. Not everybody has in-depth knowledge of how the economy works and how it affects them, and even those who did did not quite see this coming. I’m interested to hear what an alternative solution to address these individuals’ needs would be.

Matt October 5, 2008 at 1:10 pm

Deborah

Remember I said that there were only two possible winners in the scam that the FED in conjunction with the Congress that is being perpetrated, all others will be losers in either the short or long run. This process has been in process for a very long time period even the 90 yr.old you mention has been deceived throughout her life time. What is being perpetrated is not easy to understand because people have been indoctrinated that the function of the FED is legitimate and favorable for the country as a whole, whereas what is really going on is a convoluted process to benefit special interest groups at the expense of the one’s who are not part of that group.
Bottom line though is that what is going on is theft on a grand scale that periodically tries to correct itself and now as often in the past the FED in conjunction with the Congress will try to right the problems that they have created….hint: as long as the FED is in existence we will have more of the same and most likely even worse in four or five years, though it may be sooner now that the rest of the world is catching on to the theft. By the way, all of the other governments in the world are even more corrupt in their financial functions than is the U.S.
In the end the only solution is for Congress to question the Judeo/Christian Ethics upon which the system operates…Don’t hold your breath on that.

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