A reward for risk and failure

Cato's Daniel Mitchell makes the case against the bailout:

The bailout will encourage imprudent risk in the future. The debacles at Fannie Mae and Freddie Mac, as well as the savings & loan failures from the late 1980s/early 1990s, are compelling examples of the negative economic consequences that occur when profits are privatized but losses are socialized. Faced with this perverse incentive structure, people engage in riskier behavior (analogously, if you are in Vegas, and somebody else is going to cover your losses, you obviously have an incentive to make bigger bets). A bailout would extend this risky behavior to the whole financial system, if not the entire economy.

[...]

The bailout repeats the mistakes Japan made in the 1990s. There are several historical episodes that indicate the dangers of government intervention to prop up a bubble. Japan faced a similar situation at the end of the 1980s, with real estate prices rising to absurd levels. The bubble then burst, but rather than let market forces operate, Japanese politicians sought to prop up both insolvent institution and asset prices. This interfered with the orderly reallocation of labor and capital, created considerable uncertainty, and contributed to a “lost decade” of economic stagnation. Another worrisome parallel is what happened during the 1930s. Policy mistakes such as protectionism (Hoover), higher tax rates (Hoover and Roosevelt), increased government spending (Hoover and Roosevelt), and increased intervention (Hoover and Roosevelt), helped turn a stock-market correction into the Great Depression.

Damian P.

Update: Brian Doherty compares the bailout debate with the run-up to the invasion of Iraq, but I also think the parallels to the 1992 Charlottetown Accord debate - and, more recently, campaigns to pass a constitution for the European Union - are striking. Basically, you have most mainstream politicians, media outlets and commentators on one side, lined up against the far right, the far left - and, it turns out, the people.

The biggest difference, obviously, is that the bailout is not being put to a referendum.

Posted by damian at October 2, 2008 02:48 PM