Monday, March 17, 2008

Should the Fed Bail-Out Financial Institutions?

After JP Morgan and the Fed bailed out BearStearns - or rather, after JP Morgan took over BearStearns for pennies on the Dollar with tax payers guaranteeing the deal with our pocket books, the question comes to mind: should the government be bailing out these irresponsible institutions? I have previously written strongly against a bailout of sub-prime home owners. Is this any different?

Well, I think that it is. It looks like we have a major problem on our hands. We are no longer facing a situation where the economy is in a slump because of the real estate downturn. What we may be facing is possible loss of confidence in the financial system. The collapse of a major investment bank is a really, REALLY bad thing. Such a collapse could potentially start a chain reaction that would drag other financial institutions into bankruptcy and turn a run of the mill recession into something much worse.

Yes. I think that the Fed made the right call. Nevertheless, in doing the right thing, is the Fed letting the bad guys off the hook too easily and creating a situation where banks will be tempted to take reckless risks in the future? That is a possibility and for this reason I think Congress should find a way to better regulate the financial sector in a way that will make such recklessness less likely.

Economic bubbles have existed for as long as the modern economic system has been around. Consider the Tulip craze in 17th century Holland, or the South Sea bubble in 18th century England. An act of Congress is unlikely to stop the next bubble from inflating, they appear to come with the territory. However, tougher financial controls that force companies to recognize and correctly measure their risk, and to inform investors of those risks, are probably in order. On the other hand, Congress should refrain from over-regulation as well - Sarbanes-Oxley (also known as the "No Accountant Left Behind" Act) being a great example of a recent Congressional overreaction.

In the end, it appears that the Fed is doing its best to stave off the worst of the economic crisis that we are witnessing. We can all hope that they succeed.

I was actually planning to do a post about my first day in my new job today, but I guess that will have to wait for some other time...

1 comment:

Roman said...

I think that they should, but the manner that they should do it in should be with interest rate cut or anything that could cause more inflation. The Fed has to do anything possible to prevent stagflation. The finance sector is cutting to many jobs too fast for this to be prevented without saving them along the way.