A Fun, If Unlikely, Proposal

An interesting article on Reason also recommended on Marginal Revolution:

"Such simple measures—raising the capital ratio requirements of investment banks, eliminating implicit guarantees to government-sponsored enterprises, suspending mark-to-market accounting back in 2006, and extending tax cuts on capital gains and dividends into the future—would have allowed the market to continue to reorganize its financial sector at absolutely no cost to taxpayers.

That being said, if the president and Congress were dead set on addressing the lack of cash in the economy, they still could have done so in a way that would have achieved the goal of injecting liquidity into the banking system while exposing taxpayers to far less uncertainty.

How? By taking the $700 billion they plan to give to Wall Street and sending checks worth $3,600 to the 191 million U.S. taxpayers. Such checks would then have to be deposited into some type of retirement account or be subject to the IRS's premature IRA distribution rules.

The most risk-averse people would invest this windfall into relatively safe money market funds, thereby preventing the credit crunch predicted by the pundits. Some would buy instruments such as mutual funds, which would sustain the market. Savvier investors, or at least those with a high risk threshold, would profit from the low prices on Wall Street to purchase stock in distressed banks."

Read the whole post, which I find interesting and basically like. And yet, here's my one note response to all such plans:

Don the libertarian Democrat | October 8, 2008, 2:26pm | #

"When the federal government guarantees bank loans or assets, banks have less incentive to evaluate loan applicants thoroughly, but they do have an incentive to engage in riskier behavior than they would otherwise undertake."

Bingo! That's what I've been saying all along.

The reaction of the credit markets to the failure to bailout Lehman showed that the market players were expecting a bailout. The real analysis needs to take into account the real world implications of government interventions in financial crises. Without a clear understanding of what that role will be, it's hard to know exactly what investors are relying on in making many of their decisions. If they're assuming government intervention, one can assume that their decisions are different than if they weren't.

Again, we also need to know the actual assumptions that various parties in this crisis were relying on. If a government bailout is one of them, that seems very important to me to know.

The real question is whether or not government will intervene in situations like the current one. Without an answer to that, it is very hard to determine what will actually occur in the real world, or what a rational policy should be.

There's no point going on and on about the free market without knowing the actual assumptions and restrictions we're laboring under.