Philippine Daily Inquirer First Posted 21:34:00 09/17/2008
The US federal government’s last-minute bailout of American Insurance Group, the largest insurance company in the United States, has given the world’s financial markets much-needed breathing room. [Read story] Essentially, the US government decided that the collapse of Lehman Brothers and Bank of America’s buyout of Merrill Lynch constituted market upheaval the economy could bear, but that of AIG could not be countenanced. Letting AIG go under would have pushed the wobbly US economy over the edge.
The relief is real, and stock markets in Asia on Wednesday responded favorably to the news (albeit the positive reaction slowed over the course of a still-tense day). [Read story] But the problem with the US government’s $85-billion rescue, which gives it control of AIG, is that it is a short-term fix.
We can understand the decision-making that went into the policy to let Lehman Brothers, one of Wall Street’s venerable investment banks, sink. (The US government’s refusal to offer Barclay’s any guarantees in case the British bank acquired Lehman Brothers was the breaking point of the negotiations.)
Economists have a name for a key assumption (perhaps the fundamental assumption) behind that decision: “moral hazard.” Businessmen must be held accountable for their business decisions. Otherwise, if a state action or a market failure were to fully protect unsuccessful businessmen from the consequences of their incompetence, they might continue with business as usual.
In the US government’s rescue of the giant Fannie Mae and Freddie Mac mortgage funds, and in its refusal to bail out both Lehman Brothers and Merrill Lynch, both Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke insisted that management pay for their mistakes. Well and good, and truly necessary, but it is possible to argue that the handling of the earlier Bear Stearns crisis helped lead to last weekend’s financial upheaval, or at least prolonged the inevitable—and deepened the misery.
It is also possible to argue that the cause was not in fact immediate. New York Times columnist David Leonhardt agrees with top economic blogger Barry Ritholtz’s argument, fleshed out in a still-unpublished book, that the bailout of the Chrysler car manufacturing company in 1979 was the true turning point. It seemed like a resounding success (Chrysler CEO Lee Iacocca even became a folk hero), but it effectively delayed the US auto industry’s moment of reckoning.
The same thing with the US financial institutions that threw cheap credit at unqualified borrowers. What we are dealing with, at bottom, is a debt explosion. The sooner financial institutions accept the consequences of their disastrous risk-taking, the sooner the market (under pressure from governments in respective economies) can reform itself.
The decision facing governments is where to draw the line dividing morally hazardous companies that must be allowed to sink under their own weight, and similar businesses that must be saved because they would bring the economy down with them.
In other words, shed no tears for Lehman Brothers or Merrill Lynch, the famous “thundering herd” now tamed and roaming only the pastures of the Bank of America. They had it coming. But raise an eyebrow over AIG’s bailout. Will it only delay the day of reckoning?
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