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Posts Tagged ‘Bailout’

Politicians specialize in bad policy, but they go overboard during election years.

It’s especially galling to hear Bernie Sanders and Hillary Clinton compete to see who can make the most inane comments about the financial sector.

This is why I felt compelled last month to explain why the recent financial crisis had nothing to do with the absence of “Glass-Steagall” regulations.

Today, I want to address Dodd-Frank, the legislation that was imposed immediately after the crisis by President Obama and the Democrat-controlled Congress.

I’m tempted to focus on the fact that the big boys on Wall Street, such as Goldman-Sachs, supported the law. It’s galling, after all, to hear politicians claim Dodd-Frank was anti-Wall Street legislation.

But there are more important points to consider, including the fact that the law doesn’t prevent or preclude bailouts.

Writing for today’s Wall Street Journal, Emily Kapur and John Taylor identify key problems with the Dodd-Frank bailout legislation.

Sen. Sanders and others on both sides of the aisle have a point. The 2010 Dodd-Frank financial law, which was supposed to end too big to fail, has not. Dodd-Frank gave the Federal Deposit Insurance Corp. authority to take over and oversee the reorganization of so-called systemically important financial institutions whose failure could pose a risk to the economy. But no one can be sure the FDIC will follow its resolution strategy… Neel Kashkari, now president of the Federal Reserve Bank of Minneapolis, says government officials are once again likely to bail out big banks and their creditors.

Most important, they propose a new Chapter 14 of the bankruptcy code so that insolvent institutions – regardless of their size – are liquidated.

The solution is not to break up the banks or turn them into public utilities. Instead, we should do what Dodd-Frank failed to do: Make big-bank failures feasible without tanking the economy by writing a process to do so into the bankruptcy code… Chapter 14 would impose losses on shareholders and creditors while preventing the collapse of one firm from spreading to others. …the court would convert the bank’s eligible long-term debt into equity, reorganizing the bankrupt bank’s balance sheet without restructuring its operations. …Other reforms, such as higher capital requirements, may yet be needed to reduce risk and lessen the chance of financial failure. But that is no reason to wait on bankruptcy reform. A bill along the lines of the chapter 14 that we advocate passed the House Judiciary Committee on Feb. 11. Two versions await action in the Senate. Let’s end too big to fail, once and for all.

Amen. When big institutions go under, shareholders and bondholders should be the ones to bear the costs, not taxpayers.

Unfortunately, unless a new Chapter 14 of the bankruptcy code is created, it’s quite likely that regulators and politicians will simply opt for more TARP-style bailouts if big firms get in trouble.

So Dodd-Frank didn’t really do the one thing that was necessary.

But it did do a lot of things that make the system more costly and clunky.

Hester Pierce of the Mercatus Center explains that Dodd-Frank expanded regulation based on the theory that regulators can understand and plan the financial sector.

Dodd-Frank—built on the premise that markets fail, but regulators do not—places great faith in regulators to identify and stop problems before they develop into a crisis. …Dodd-Frank, despite language to the contrary, keeps the door open for future bailouts. …Dodd-Frank includes many provisions that are not related to financial stability, but fails to deal with key problems made evident by the crisis. …Dodd-Frank’s drafters chose to leave many key decisions to regulators. The contours of systemic risk, for example, were left to regulators to define. Moreover, because the prevailing narrative of the crisis focused on market failure, Dodd-Frank expanded regulators’ authority to shape the financial system. In addition to their substantial rule-writing responsibilities, under Dodd-Frank regulators now play a central role in monitoring, planning, and managing the financial markets.

Most worrisome, Hester notes that Dodd-Frank has provisions that benefit the big firms and may make them more likely to get bailouts.

Dodd-Frank gives FSOC broad powers to designate nonbank financial institutions and financial market utilities (such as derivatives clearinghouses) systemically important. …Designated firms are likely to be perceived as the firms the government is likely to rescue… Dodd-Frank was supposed to mark the end of taxpayer bailouts of financial firms. This pledge is undermined in several ways by the statute’s other provisions and the regulatory-centric approach that cuts across the whole statute. …The pressure on regulators to conduct bailouts is likely to be particularly strong with respect to systemically important institutions. …Regulatory failure played an important role in the last crisis by concentrating resources in the housing sector, encouraging reliance on credit-rating agencies, and driving financial institutions to concentrate their holdings in mortgage-backed securities. Dodd-Frank gives regulators more authority and broad discretion to shape the financial sector and the firms operating within it. When the regulators fail at this ambitious mission, they will again face internal and external pressure to cover those failures with a taxpayer-funded bailout.

Two other Mercatus experts, Patrick McLaughlin and Oliver Sherouse, show that regulators were among the biggest beneficiaries of the law. The law has led to a massive explosion in red tape.

The statute, which itself was 848 pages long, directed dozens of regulatory agencies to revise or create new regulations addressing the financial system in the United States. Those agencies responded with hundreds of new rules that will govern financial markets, on a scale that vastly exceeds any previous regulation of financial markets, and dwarfs the regulations that accompanied all other legislation enacted during the Obama administration. …Dodd-Frank…is associated with more than five times as many new restrictions as any other law passed since January 2009, for a total of nearly 28,000 new restrictions. In fact, it is associated with more new restrictions than all other laws passed during the Obama administration put together.

Here’s a rather sobering chart from the report.

Amazingly, the red tape generated by Dodd-Frank is roughly equal to all the regulation generated by every other law that’s been imposed during the Obama years.

Including the notoriously Byzantine Obamacare legislation.

All these new rules actually create a competitive advantage for big financial institutions.

Peter Wallison of the American Enterprise Institute has a must-read study on how Dodd-Frank imposes disproportionately heavy costs on small banks and small businesses.

…the reason for the slow recovery is the Dodd-Frank Act, enacted in 2010, which placed heavy regulatory costs and new restrictive lending standards on small banks. This in turn reduced the ability of these banks to finance small businesses, particularly the start-up businesses which are the engine of employment and economic growth. Large businesses have not been subject to the same restrictions because they have access to the capital markets, and their growth has been in line with prior recoveries. …recoveries after financial crises tend to be sharper than other recoveries, not slower as some have suggested. It is likely that, without the repeal or substantial reform of Dodd-Frank, the U.S. economy will continue to grow only slowly into the future. ……whatever regulatory costs are imposed on banking organizations— whether they be $2 trillion banks like JPMorgan Chase, $50 billion banks or $50 million banks— the larger the bank the more easily it will be able to adjust to these costs.

What’s especially frustrating is that the law was imposed because of a fundamental misunderstanding of what caused the crisis.

…the incoming administration of Barack Obama and the Democratic supermajority in Congress blamed the crisis on insufficient regulation of the private financial sector. This narrative, although factually unsupported, gave rise to the Dodd-Frank Act, which imposed significant new regulation on the US financial system but did virtually nothing to reform the government policies that gave rise to the financial crisis. …In developing and adopting the Dodd-Frank Act, Congress and the administration did not appear to be concerned about placing additional regulatory costs on the financial system.

Here’s the bottom line. Regulation is no replacement for market discipline.

And bankruptcy needs to be part of that discipline. After all, capitalism without bankruptcy is like religion without hell.

P.S. To give you an idea of how unserious politicians are, the Dodd-Frank law didn’t end bailouts, but it did create new racial and sexual quotas. So I guess we can take comfort in the fact that the bureaucracy will reflect all of America the next time they rip off taxpayers.

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Remember the odious, immoral, and corrupt TARP bailout?

Well, it’s becoming an issue in the 2016 presidential race, with some folks criticizing Donald Trump for siding with Bush and Obama on the issue.

I suppose I could make a snide observation about the absurdity of Trump being perceived as an anti-establishment candidate when he supported a policy that had unanimous support from political insiders.

But I would much rather focus on the policy implications. So when Neil Cavuto asked me to comment on Chris Christie’s rejection of bailouts, I took the opportunity to stress (once again) that it wasn’t a TARP-or-nothing choice and that there was a sensible, non-corrupt, way of dealing with failing financial firms. Simply stated, only bail out depositors and let bondholders and shareholders take the hit.

For the geeks who are reading this, you’ll recognize that the policy I’m advocating is often called the FDIC-resolution approach.

And it’s worth noting that this was used at the beginning of the financial crisis. As I pointed out in the discussion, two of the big financial institution that first got in trouble – WAMU and IndyMac – were liquidated.

But once Bush’s execrable Treasury Secretary, Hank Paulson, took control of the process, decisions were made to rescue the fat cats as well as the depositors.

The bottom line is that a lot of establishment figures, including GOPers like Dick Cheney and Mitt Romney, argue that TARP was necessary because the financial system needed to be recapitalized.

Yet that’s also what happens with the FDIC-resolution approach. The only real difference is whether financial institutions should be rescued along with depositors.

Well, my view is that capitalism without bankruptcy is like religion without hell.

P.S. The other guest in the interview made a very good point about America becoming “bailout nation.” I fully agree. To the extent that we have private profits and socialized losses, we’ll have bigger and bigger problems with moral hazard. After all, if you’re in Las Vegas and someone else is covering your losses, why not make high-risk/high-reward bets.

P.P.S. If anyone cares, my driveway is finally clear. A special thanks to the family next door. Not only were they smarter than me (as I wrote yesterday, they parked their cars near the end of their driveway), they’re also nicer than me. They came over and helped me finish when they were done!

Actually, I like to think I’d be equally thoughtful. I’ll have to look for a chance to repay their good deed.

By the way, I should add that the father next door works for a social conservative organization, which is one more piece of evidence for my view that so-cons and libertarians should be allies.

Tim Carney explains that natural alliance much better.

P.P.P.S. In hopes of convincing some of my leftist friends, I can’t resist making one final point.

When government gets to pick winners and losers, it’s highly probable that those who get the handouts, bailouts, and subsidies will be rich, powerful, and politically connected. Heck, just think of the Ex-Im Bank.

As noted by my former colleague, Will Wilkinson, “…the more power the government has to pick winners and losers, the more power rich people will have relative to poor people.”

I realize that statists won’t agree with me that it’s wrong for the federal government to redistribute from rich to poor. But I hope they’ll be on my side in fighting against redistribution from poor to rich!

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Shortly after Obamacare was enacted, I started writing about groups victimized by the law. But after highlighting how children, low-income workers, and retirees were disadvantaged by government-run healthcare, I soon realized that I wasn’t saying anything new or different.

Heck, Obamacare has been such a disaster that lots of people have been writing lots of good articles about the law’s failure and how various segments of the population are being unjustly harmed.

So I chose a different approach. I decided to identify groups that deserve to suffer because of the law. Or at least to highlight slices of the population that are not very deserving of sympathy.

Some politicians and staffers of Capitol Hill, for instance, are very upset about the prospect of being subjected to the law that they inflicted on the rest of the country. Gee, my heart breaks for them.

The bureaucrats at the IRS are agitated about the possibility of living under Obamacare, even though the IRS got new powers as a result of the law. How sad, cry me a river.

Professors at Harvard University, including many who supported Obamacare, are now upset that the law is hurting them. Oh, the inhumanity!

Now we have another group to add to this list. And this group is definitely in the deserve-to-suffer category.

That’s because we’re going to look at the big insurance companies that supported Obamacare, but now are squealing because the law isn’t working and they’re not getting the bailouts they were promised.

Here are some excerpts from a column by the irreplaceable Tim Carney of the Washington Examiner.

Until recently, the insurance giants saw Obamacare as a cash cow. They are now finding the law’s insurance marketplaces to be sickly quagmires causing billions in losses. …United Healthcare, the nation’s largest insurer, last week announced it was suffering huge losses in the exchanges. …The company forecast $700 million in losses on the exchanges. Fellow insurance giant Aetna also said it expected to lose money on the exchanges, and other insurers said enrollment was lower than they expected.

This seems like a feel-good story, very appropriate for the holidays. After all, companies that get in bed with big government deserve bad consequences.

But hold on to your wallet.

…Obamacare insiders — the wealthy and powerful operatives who alternate between top government jobs and top industry jobs — are hustling to find more bailout money for insurers. Republicans, if they are able to hold their ground in the face of lobbyist pressure, can block the bailout of Obamacare and its corporate clientele. …Obamacare included…a three-year safety net for insurers who do much worse than expected, paid for by an extra tax on insurers who do much better. The Centers for Medicare & Medicaid Services (CMS) had announced in October that insurers losses for 2014 entitled them to $2.87 billion in bailout payments… The problem is that super-profitable insurers did not pay nearly that much into the bailout fund.

This means there will be a fight in Washington. The Obama White House wants to bail out its corporate cronies. But there’s not enough money in the bailout fund.

And, thanks to Senator Rubio of Florida, the government can’t write checks out of thin air.

In late 2014, Sen. Marco Rubio, R-Fla., inserted into the so-called Cromnibus spending bill a provision that prohibited CMS from paying out more in risk corridor payments than it takes in. Profitable insurers — not taxpayers — must subsidize their less profitable peers.

Unfortunately, the Obama Administration oftentimes doesn’t care what the law says.

CMS announced last week that the government was going to find a way to pay the insurers their full bailout, anyway. …CMS also declared the unfunded portion of Obamacare’s initial promised insurer bailout was nevertheless an “obligation of the United States Government for which full payment is required,” even though at least under the current appropriation law it is illegal.

Tim outlines the incestuous relationship between Big Insurance and the Obama White House, all of which makes for nauseating reading.

But here’s the part that matters for public policy.

Rubio’s provision…expires along with the current government funding law on December 11. The Obamacare insiders, led by Slavitt and Tavenner, will fight to free up their bailouts and put the taxpayers on the hook for their losses caused by the law they supported.

In other words, we’re about to see – as part of upcoming appropriations legislation – if Republicans have the intelligence and fortitude to retain Rubio’s anti-bailout provision.

This should be a slam-dunk issue. After all, the American people presumably will not favor bailouts for corrupt health insurance corporations.

Especially since Obamacare is still very unpopular.

But what if Obama says “boo” and threatens to veto spending legislation if it doesn’t give him carte blanche bailout authority? Will GOPers be so scared of a partial government shutdown that they instantly surrender?

After all, when there was a shutdown fight in 2013, Republicans suffered a horrible defeat in the 2014 mid-term elections. Right? Isn’t that what happened?

Oh…wait…never mind.

P.S. Let’s not forget that there is one very tiny segment of America that has unambiguously benefited from Obamacare.

P.P.S. If you have any friends who work for the corrupt health insurance companies that are worried about a potential loss of bailout money, you can cheer them up this Christmas season with some great – and very appropriate – action figure toys.

P.P.P.S. Since we’re closing with sarcasm, here’s the federal government’s universal bailout application form.

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Is the third time the charm, at least for bailouts?

First, we had the TARP bailout in the United States, and that turned out to be a corrupt mess.

Second, we had the Greek bailout, which has squandered hundreds of billions of euros to prop up a welfare state.

Now we have a third big bailout, with China seeking to stabilize that nation’s faltering stock market. So anybody want to guess how this will work out?

To put it mildly, the Wall Street Journal does not have a favorable opinion of this financial market intervention.

Beijing…officials pumped public money into the market. It hasn’t worked; the Shanghai Composite Index closed Thursday at 3661, 29% below its June peak. …Peking University economist Christopher Balding has added up the bailout and stimulus measures announced since the market panic started in late June. They total $1.3 trillion, or more than 10% of GDP.

So why is this a bad thing?

For two reasons, as the WSJ explains. First, it’s an unjustified wealth transfer. Second, it creates an economic environment contaminated by moral hazard.

Investors who bought when the market was already frothy are getting a chance to exit with some of their profits intact. But Chinese who don’t own stocks are justified in asking why they must subsidize their fellow citizens’ poor decisions. Mr. Balding’s spreadsheet shows that the market-rescue measures represent a huge transfer of wealth to investors who should have been prepared to shoulder the risks when they bought shares. The failed bailout reinforces the expectation that Beijing will attempt to manage the financial markets in the future. This moral hazard means the volatility will continue, along with the costs of future bailouts.

You won’t be surprised to learn that I share the Wall Street Journal’s skepticism. In a recent interview with Neil Cavuto, I said the Chinese government (like just about all governments) is too focused on short-run pain avoidance.

In other words, by trying to prop up markets in the short run, I think the Chinese government will cause a far greater amount of economic pain in the long run.

Two other points from the interview deserve highlighting.

  1. China’s economy needs more economic liberalization (as opposed to the snake oil being peddled by the IMF) if it hopes to become a first-world nation. While there’s been a lot of progress since the wretched deprivation and poverty of Mao’s era, China is still way behind the United States and other nations with more capitalistic systems. Hong Kong, Singapore, and Taiwan are appropriate role models.
  2. Whenever folks on the left point to a “success story” that ostensibly proves big government and central planning are more successful that capitalism, it’s just a matter of time before they’re proven wrong. Some of them were delusional enough to think the Soviet Union was economically successful (see bottom of this post) and events proved them wrong. As I pointed out in the interview, some of them thought Japan’s model of central planning was the ticket for prosperity and events proved them wrong. More recently, some of them have argued that China’s state-driven economy was a role model and they’re now being shown to be wrong.

P.S. Let’s close with some economic humor.

Fans of old-time comedy are probably familiar with the famous who’s-on-first exchange between Abbott and Costello.

Well, here’s a modern version of that exchange that showed up in my mailbox yesterday, only it deals with joblessness. I won’t strain credibility by asserting it’s as funny as the original sketch, but it does indirectly highlight the fact that we should focus primarily on labor force participation since that measure how many people are producing wealth for the nation.

COSTELLO: I want to talk about the unemployment rate in America.

ABBOTT: Good Subject. Terrible times. It’s 5.6%.

COSTELLO: That many people are out of work?

ABBOTT: No, that’s 23%.

COSTELLO: You just said 5.6%.

ABBOTT: 5.6% unemployed.

COSTELLO: Right, 5.6% out of work.

ABBOTT: No, that’s 23%.

COSTELLO: Okay, so it’s 23% unemployed.

ABBOTT: No, that’s 5.6%.

COSTELLO: Wait a minute! Is it 5.6% or 23%?

ABBOTT: 5.6% are unemployed. 23% are out of work.

COSTELLO: If you are out of work, you are unemployed.

ABBOTT: No, Congress said you can’t count the “out of work” as the unemployed. You have to look for work to be unemployed.

COSTELLO: But they are out of work!

ABBOTT: No, you miss his point.

COSTELLO: What point?

ABBOTT: Someone who doesn’t look for work can’t be counted with those who look for work. It wouldn’t be fair.

COSTELLO: To whom?

ABBOTT: The unemployed.

COSTELLO: But ALL of them are out of work.

ABBOTTNo, the unemployed are actively looking for work. Those who are out of work gave up looking; and if you give up, you are no longer in the ranks of the unemployed.

COSTELLO: So if you’re off the unemployment rolls, that would count as less unemployment?

ABBOTT: Unemployment would go down. Absolutely!

COSTELLOThe unemployment rate just goes down because you don’t look for work?

ABBOTTAbsolutely it goes down. That’s how it gets to 5.6%. Otherwise it would be 23%.

COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?

ABBOTT: Two ways is correct.

COSTELLO: Unemployment can go down if someone gets a job?

ABBOTT: Correct.

COSTELLO: And unemployment can also go down if you stop looking for a job?

ABBOTT: Bingo.

COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to have people stop looking for work.

ABBOTT: Now you’re thinking like an economist.

COSTELLO: I don’t even know what the hell I just said!

ABBOTT: Now you’re thinking like a politician.

P.P.S. While economists deservedly get mocked, we’re not totally useless. We occasionally show a bit of cleverness.

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I’ve shared lots of analysis (both serious and satirical) about the mess in Greece and I feel obliged to comment on the latest agreement for another bailout.

But how many times can I write that the Greek government spends too much money and has a punitive tax system (and a crazy regulatory regime, a bloated bureaucracy, etc)?

So let’s try a different approach and tell a story about the new bailout by using some images.

Here’s an amusing perspective on what actually happened this weekend.

I explained a few days ago that the bailouts have simultaneously enabled the delay of much-needed spending reforms while also burdening Greece with an impossible pile of debt.

But the Greek bailouts, like the TARP bailout in the United States, were beneficial to powerful insiders.

Here’s a look at how banks in various European nations have been able to reduce their exposure to Greek debt.

Sure, the banks almost surely still lost money, but they also transferred a lot of the losses to taxpayers.

To get a sense of the magnitude of handouts, here’s a chart from a Washington Post story.

And now, assuming the deal gets finalized, that pile of foolish and unsustainable debt will be even bigger.

One of the main components of the new agreement is that Greece supposedly will raise revenue by selling $50 billion of state-owned assets.

Don’t believe that number. But not because there aren’t plenty of assets to sell, but rather because the track record on privatization proceeds suggests that there is a giant gap between what Greece promises and what Greece delivers.

To understand why assets aren’t being sold, just keep in mind that most of the assets are under the control of the government in order to provide unearned benefits to different interest groups.

If you’re an overpaid unionized worker at a government-owned port, for instance, the last thing you want is to have that port sold to a private investor who presumably would want to link pay to productivity.

Here’s the best bit of humor I’ve seen about the negotiations this past weekend. It purports to show a list of demands from Germany to Greece.

While this image is funny, it’s also wrong.

Germany isn’t imposing anything on Greece. The Germans are simply stating that Greek politicians need to make some changes if they want more handouts.

Moreover, it’s quite likely that Germany will wind up being a big loser when the dust settles. Here’s some of what Gideon Rachman wrote for the U.K.-based Financial Times.

If anybody has capitulated, it is Germany. The German government has just agreed, in principle, to another multibillion-euro bailout of Greece — the third so far. In return, it has received promises of economic reform from a Greek government that makes it clear that it profoundly disagrees with everything that it has just agreed to. The Syriza government will clearly do all it can to thwart the deal it has just signed. If that is a German victory, I would hate to see a defeat.

So true.

I fear this deal will simply saddle Greece with a bigger pile of debt and set the stage for a more costly default in the future.

The title of this column is about pictures. But let’s close with some good and bad analysis about the Greek mess.

Writing for Real Clear Markets, Louis Woodhill has some of the best insight, starting with the fact that the bailout does two things.

First, this new bailout is largely just a mechanism to prevent default on past bailouts. Sort of like making a new loan to your deadbeat brother-in-law to cover what he owes you on previous loans.

…the €53.5 billion in new loans…would just be recycled to Greece’s creditors (the IMF, the EU, and the ECB) to pay the interest and principal on existing debts.

Second, it prevents the full meltdown of Greek banks.

The key point is that a bailout agreement would restore European Central Bank (ECB) “Emergency Liquidity Assistance” (ELA) to the Greek banking system. This would allow Greeks that still have deposits in Greek banks (€136.5 billion as of the end of May) to get their money out of those banks.

That’s good news if you’re a Greek depositor, but that’s about it.

In other words, those two “achievements” don’t solve the real problem of Greece trying to consume more than it produces.

Indeed, Woodhill correctly identifies a big reason to be very pessimist about the outcome of this latest agreement. Simply stated, Greek politicians (aided and abetted by the Troika) are pursuing the wrong kind of austerity.

…what is killing Greece is a lack of economic growth, and the meat of Tsipras’ bailout proposal consists of growth-killing tax hikes. The media and the economics profession have been framing the alternatives for Greece in terms of a choice between “austerity” and “stimulus.” Unfortunately for Greece, austerity has come to mean tax increases, and stimulus has come to mean using “other people’s money” (mainly that of German taxpayers) to support Greek welfare state outlays. So, if “other people” aren’t willing to fund more Greek government spending, then the only option the “experts” can imagine is to raise taxes on an economy that is already being crushed by excessive taxation.

Let’s close with the most ridiculous bit of analysis about the Greek situation. It’s from Joe Stiglitz,

Joseph Stiglitz accused Germany on Sunday of displaying a “lack of solidarity” with debt-laden Greece that has badly undermined the vision of Europe. …”Asking even more from Greece would be unconscionable. If the ECB allows Greek banks to open up and they renegotiate whatever agreement, then wounds can heal. But if they succeed in using this as a trick to get Greece out, I think the damage is going to be very very deep.”

Needless to say, I’m not sure why it’s “solidarity” for one nation to mooch in perpetuity from another nation. I suspect Stiglitz is mostly motivated by an ideological desire to redistribute from the richer Germans to the poorer Greeks,

But I’m more interested in why he isn’t showing “solidarity” to me. I’m sure both his income and his wealth are greater than mine. So if equality of outcomes is desirable, why doesn’t he put his money where his mouth is by sending me a big check?

Needless to say, I won’t be holding my breath waiting for the money. Like most leftists, Stiglitz likes to atone for his feelings of guilt by redistributing other people’s money.

And I also won’t be holding my breath waiting for a good outcome in Greece. As I wrote five-plus years ago, Greece needs the tough-love approach of no bailouts, which would mean a default but also an immediate requirement for a balanced budget.

Last but not least, I’m going to confess a possible mistake. I always thought that Margaret Thatcher was right when she warned that the problem with socialism is that you eventually run out of other people’s money. But this latest bailout of Greece shows that maybe politicians from other nations are foolish enough to provide an endless supply of other people’s money.

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I very rarely feel sympathy for the people of Greece. Indeed, events over the past five years have even led me to write that “I hate the Greeks.”

I also disparaged the people of Greece by stating on TV that they’ve been trying to loot and mooch their way through life.

So you can see that I generally believe in the tough-love approach.

But there comes a point when even a curmudgeon like me is going to say enough is enough and that the Greek people have suffered enough already.

And I had that experience yesterday. Check out this headline from a story in yesterday’s EU Observer.

Economic advice from the French government?!? Isn’t that a bit like asking the Chicago Cubs for suggestions on how to win the World Series?

What are the French advisers going to do, propose ways to make the government even bigger? Suggest ways of driving even more entrepreneurs out of the country?

For Heaven’s sake, this is the last thing the people of Greece need.

Sort of reminds me of a headline I saw attached to a report by Reuters a few years ago.

Geesh, the Greeks already suffered because of an invasion by people working for the German government back in the 1940s. Seems like another deployment of German bureaucrats would be adding insult to injury.

Particularly since it would create the worst of all worlds, marrying Teutonic tax efficiency (for example, taxing prostitutes with parking meters) with Greek profligacy (for example, subsidies for pedophiles).

I’m not sure where that would end, but it surely wouldn’t be a good place.

Now let’s make a more serious point about tough love and Greek suffering.

Back in early 2010, about the time the Greek fiscal crisis was becoming a big issue, I warned that a bailout would actually make things worse. I suggested it would be better to let Greece default, both because it would penalize foolish investors who lent too much money to the Greek government and because it would force Greece to live within its means.

That would have meant short-run pain, to be sure, but I think that approach would have involved the least amount of aggregate suffering.

But the political class ignored my helpful advice and instead decided that bailouts would be a better idea. But how has that worked out? The Greek economy has been moribund and the Greek people are now saddled with far more debt. Yes, some short-run pain was mitigated, but only at the cost of much more pain over the past few years (with more pain in the future).

Interestingly, the International Monetary Fund’s top economist unintentionally has confirmed my analysis. Here’s some of what Olivier Blanchard recently posted as part of an effort to defend the IMF’s choices back in 2010.

Had Greece been left on its own, it would have been simply unable to borrow. …Even if it had fully defaulted on its debt, given a primary deficit of over 10% of GDP, it would have had to cut its budget deficit by 10% of GDP from one day to the next.  These would have led to much larger adjustments and a much higher social cost.

Blanchard obviously thinks reducing government spending by 10 percent of GDP would have imposed too much “social cost,” but imagine if Greece had bitten the bullet back in 2010. Sort of like what Estonia did in 2009.

Yes, there would have been a challenging adjustment. Interest groups would have received fewer handouts. Greek bureaucrats would have lost jobs and/or had their pay reduced. Payments to vendors would have been delayed. State-run TV may have been shut down. The regulatory apparatus probably would have been cut back. And I’m sure the Greek government probably would have raised taxes as well.

Now imagine how much better off Greece would be today if it went with that approach.

We don’t have a parallel universe where we can see the results of that different approach, but consider the fact that Estonia had a deeper downturn than Greece, presumably in part because it undertook strong measures, but since that time has been Europe’s fastest-growing economy.

Greece, by contrast, has been Europe’s slowest-growing economy. Hmmm…seems like this should be part of any discussions about “social cost.”

So what lessons can we learn?

I realize there are lots of factors that determine economic performance and that it’s impossible to isolate the impact of either Estonia’s spending-cut policy or Greece’s bailout policy. But it would take a very bizarre and untenable set of assumptions to conclude that Estonia didn’t make smarter policy choices.

The only silver lining to Greece’s dark cloud is that it’s not too late to do the right thing.

P.S. Since we ended by speculating about the good results of my tough-love approach, let’s also enjoy some Greek-related humor.

This cartoon is quite  good, but this this one is my favorite. And the final cartoon in this post also has a Greek theme.

We also have a couple of videos. The first one features a video about…well, I’m not sure, but we’ll call it a European romantic comedy and the second one features a Greek comic pontificating about Germany.

Last but not least, here are some very un-PC maps of how various peoples – including the Greeks – view different European nations.

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When debating and discussing the 2008 financial crisis, there are two big questions. And the answers to these questions are important because the wrong “narrative” could lead to decades of bad policy (much as a mistaken narrative about the Great Depression enabled bad policy in subsequent decades).

  1. What caused the crisis to occur?
  2. What should policy makers have done?

In a new video for Prager University, Nicole Gelinas of the Manhattan Institute succinctly and effectively provides very valuable information to help answer these questions. Particularly if you want to understand how the government promoted bad behavior by banks and created the conditions for a crisis.

Here are some further thoughts on the issues raised in the video.

Deregulation didn’t cause the financial crisis – Nicole explained that banks got in trouble because of poor incentives created by previous bailouts, not because of supposed deregulation. As she mentioned, their “risk models” were distorted by assumptions that some financial institutions were “too big to fail.”

But that’s only part of the story. It’s also important to recognize that easy-money policies last decade created too much liquidity and that corrupt subsidies and preferences for Fannie Mae and Freddie Mac steered much of that excess liquidity into the housing sector. These policies helped to create the bubble, and many financial institutions became insolvent when that bubble burst.

TARP wasn’t necessary to avert a meltdown – Because the video focused on how the “too big to fail” policy created bad incentives, there wasn’t much attention to the topic of what should have happened once big institutions became insolvent. Defenders of TARP argued that the bailout was necessary to “unfreeze” financial markets and prevent an economic meltdown.

But here’s the key thing to understand. The purpose of TARP was to bail out big financial institutions, which also meant protecting big investors who bought bonds from those institutions. And while TARP did mitigate the panic, it also rewarded bad choices by those big players. As I’ve explained before, using the “FDIC-resolution” approach also would have averted the panic. In short, instead of bailing out shareholders and bondholders, it would have been better to bail out depositors and wind down the insolvent institutions.

Bailouts encourage very bad behavior – There’s a saying that capitalism without bankruptcy is like religion without hell, which is simply a clever way of pointing out that you need both profit and loss in order for people in the economy to have the right set of incentives. Bailouts, however, screw up this incentive structure by allowing private profits while simultaneously socializing the losses. This creates what’s known as moral hazard.

I’ve often used a simple analogy when speaking about government-created moral hazard. How would you respond if I asked you to “invest” by giving me some money for a gambling trip to Las Vegas, but I explained that I would keep the money from all winning bets, while financing all losing bets from your funds? Assuming your IQ is at least room temperature, you would say no. But our federal government, when dealing with the financial sector, has said yes.

Good policy yields short-run pain but long-run gain – In my humble opinion, Nicole’s most valuable insight is when she explained the long-run negative consequences of the bailouts of Continental Illinois in 1984 and Long-Term Capital Management in 1998. There was less short-run pain (i.e., financial instability) because of these bailouts, but the avoidance of short-run pain meant much more long-run pain (i.e., the 2008 crisis).

Indeed, this “short termism” is a pervasive problem in government. Politicians often argue that a good policy is unfeasible because it would cause dislocation to interest groups that have become addicted to subsidies. In some cases, they’re right about short-run costs. A flat tax, for instance, might cause temporary dislocation for some sectors such as housing and employer-provide health insurance. But the long-run gains would be far greater – assuming politicians can be convinced to look past the next election cycle.

Let’s close by re-emphasizing a point I made at the beginning. Narratives matter.

For decades, the left got away with the absurd statement that the Great Depression “proved” that capitalism was unstable and destructive. Fortunately, research in recent decades has helped more and more people realize that this is an upside-down interpretation. Instead, bad government policy caused the depression and then additional bad policy during the New Deal made the depression longer and deeper.

Now we have something similar. Leftists very much want people to think that the financial crisis was a case of capitalism run amok. They’ve had some success with this false narrative. But the good news is that proponents of good policy immediately began explaining the destructive role of bad government policy. And if Nicole’s video is any indication, that effort to prevent a false narrative is continuing.

P.S. The Dodd-Frank bill was a response to the financial crisis, but it almost certainly made matters worse. Here’s what Nicole wrote about that legislation.

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