Bankruptcy versus Bailouts
The market approach to financial problems is to
let failed firms go bankrupt. When firms
do not have enough revenue and cannot borrow to pay their bills, they should
disappear. Banks make money by borrowing
from lenders at a low interest rate and lending to borrowers at a higher rate. When a bank makes too many bad loans that
borrowers cannot pay back, it should go bankrupt. Insurance companies help avoid risk,
collecting premiums from customers and paying those who have bad luck. If the incoming premiums are less than the
insurance company has to pay out in claims, it should go bankrupt.
Bankruptcy is a normal part of
economic life with laws that guarantee debtors and then stockholders will be
paid as much as possible. A bankrupt
firm has the chance to reorganize and learn from its mistakes. More efficient firms take over what is left. When the largest US energy company Enron went
bankrupt there was hardly a ripple in energy markets.
Fannie Mae is a failed government bank
providing backing to mortgage banks and encouraging bad loans. This artificial support elevated housing
demand prior to the financial collapse.
Rising prices made home buyers confident they could buy an overpriced
house and sell it soon for a profit to the proverbial greater fool. The present mortgage mess is a result of
government meddling. Freddie Mac is a
government mortgage bank that sells mortgages without the usual restraint of
making a profit. The government
subsidizes bankrupt Fannie and Freddie with losses paid by taxpayers. The mortgage business would be much healthier
without government interference.
The government bailout taxes those who
have paid their mortgages and transferring the money to those who have not,
rewarding uneconomic behavior. The
underlying goal of the bailout is to keep a few large Wall Street banks,
insurance companies, and a car company or two in business. Wall Street is much less important now than
in the past due to national and global financial competition. Detroit has diminished greatly in the automobile
industry. Had these firms simply gone
bankrupt, the economy would have recovered quickly.
It is never too late to let markets
operate and let inefficient firms go bankrupt.
The government should get out of the bailout business.