Why bailouts are difficult

HT Mark Thoma: via Justin Fox (and I note with weeping gratitude the pundit’s confession that he doesn’t know enough to pass any decent judgement on the arguments).  Me too.

Australian money manager John Hempton owned Washington Mutual preferred shares and was thus wiped out when the bank was seized and flipped to JP Morgan Chase last week. But he’s not mad about that. He’s mad about what happened to owners of Wamu bonds. By also wiping out senior debt holders at Wamu, he argues, the government has now botched things in a profoundly serious way:

This was by far the least justified government action of this credit cycle. And it spells doom for any bank in America that is ultimately reliant senior (and hence well protected) but unsecured financing because it is so capricious. 

Thos banks are many but we can start with Wachovia whose destiny (failure) is now nearly certain and for whom the precedent is set. But after that we can go for all the banks including the champions such as Bank of America and Citigroup. Creditors now face confiscation of their rights by the US Government without oversight or audit or even process.

At that point there is no creditors and the economy collapses. The trust needed to make capitalism worked has been removed. I am not a conservative – but I will argue – along with many conservatives – that the most important function of government in a capitalist society is provision of a framework by which property rights can be defined and enforced as this is the key to making a capitalist society function. The Government is now acting as if the framework does not apply to them. That is bad whatever your political persuasion.

Hempton thinks that if the FDIC had simply liquidated Wamu, some money would have been left for the senior creditors. By choosing not to do that–presumably because it would have meant a big hit to the FDIC insurance fund–it has discouraged anybody else from providing that kind of credit to U.S. banks.

I’m afraid I don’t have the expertise to tell you whether he’s right or not. I do get the sense, though, that we’ve reached the stage in this crisis where actions meant to avoid outlays of taxpayer money now will simply result in bigger outlays later. 

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15 years ago

I think this is similar to the criticism of Paulson from Anatole Kaletsky on the previous bailouts even before WAMU?