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The Paradox of Bailouts

Posted by Steve Markowitz on January 7, 2012

Since the failure of Lehman Brothers, governments worldwide have responded with bailouts and flooding the market with liquidity, i.e. printing money.  These radical actions have been justified with the claim that without them, financial Armageddon would have occurred.  It is not possible to now determine if that was the case.  However, it is clear that these actions enabled those who made bad financial decisions to be rescued at the expense of others who acted more prudently.

Unsaid by those who favored the bailouts and other related policies were the potential repercussions of these radical actions.  Some of the repercussions have already been felt, most notably the ongoing sovereign debt issues in Europe and the unemployment rates in the West that remain stubbornly high.  Other lurking issues include new asset bubbles yet the pop and the potential for significant inflation.  Whether each of these possibilities occur is not the issue.  However, there will be costs associated with the alchemy inflicted on the economy by these actions.  The fact that those who implemented the policies refuse to even acknowledge the downside potentials and instead advocate even more intervention is a clear indication of the dangers lurking.

Recently, Dr. John P Hussman of hussman funds.com, posted his New Year’s greeting with his hope for 2012, included below.  These brief comments asked the right questions and points appropriate solutions for the paradox of bailouts.

John P. Hussman, Ph.D. (hussmanfunds.com)

Happy New Year.  We enter 2012 with a great deal of hope, but our hopes are not for more bailouts, or money printing, or any of the myriad policies that investors seem to hope will save bad investments and sustain elevated valuations.  Instead, our hope is that in 2012, the market will finally “clear,” in the sense that bad debt around the world will be recognized as bad and restructured; that overleveraged financials will be taken into receivership instead of forcing austerity on every corner of the global economy in order to make them flush again; that rates of return will rise enough to compensate and encourage saving – and high enough to encourage borrowers and other users of capital to allocate the funds productively.  Of course, in order to restructure bad debt, someone has to accept a loss.  In order for rates of return to rise, valuations must decline.  In short, our hope is for events that will unchain the global economy from an irresponsible past and open the gates toward a prosperous future.  Maybe that is too hopeful, but we are not entirely convinced that bailouts and ‘big bazooka’ will be as easily procured in the year ahead as a confused public has allowed in recent years.”

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2 Responses to “The Paradox of Bailouts”

  1. The problem was the financial deregulation that occurred starting since the 90s and huge firms becoming very interconnected. We need creative policies to deal with the latter problem.Hopefully, this episode in economics history is not forgotten.

  2. Financial deregulation is only part of the problem. Part and parcel with some of the ill-advised changes in regulations were the government’s continual market interventions. There are too many to list here, but certainly high on the list are the artificially low interest rates that began with the 9/11 downturn. These low rates created bubbles and speculation and led directly to the ongoing economic problems that are now worldwide and affecting sovereign debt.

    Unfortunately, the governments did not learn from this you error and instead has doubled down on that bet since the financial meltdown of 2008. Governments once again pushed interest rates to artificially low levels this has and will continue to significant economic problems in the years ahead.

    When history rights about this historic downturn, it will certainly play some of the blame on deregulation, but will include significant chapters on the governments in net meddling. Unfortunately this is all happened before. As soon as a good times return, and they will, the same errors will be repeated.

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