(1) is "too big to fail" always incorrect?
(2) why?
I was speaking to a true blue Democrat friend of mine, and this is one of the first things he said when I mentioned the $700 billion TARP, and how Paulson et al. were wrong that it was a necessary emergency measure to avoid Great Depression II---he said "Well, the big banks were simply too big to fail."
I know this must be wrong, but I don't know exactly why. Wouldn't a lot of "innocent bystanders" (i.e. those holding IOU's from big banks) get mowed down in the process of "letting the big banks fail?"
Edit: It's the FEAR that seems vital to address when speaking with the typical citizen, like my Democrat friend. It's the FEAR that the bank, because it's just SO DAMN BIG (i.e. its reach extends far and wide in the economy---presumably at least), surely it must be vitally devastating to let it go down.
Would allowing the big banks to fail actually be economically devastating to the economy in the short-run or medium-run, as feared?
In a free market, there would be no such thing as "too big to fail", because firms would never be able to grow to a size which would make them so vital to the economy. Since the market has been so distorted by state intervention, perhaps companies which have influenced themselves into position as "vital" to our economy do exist. Of course, as an advocate of truly free markets, one must consider that the collape of the status quo would not be so terrible...
bcyclwutztht:I know this must be wrong, but I don't know exactly why. Wouldn't a lot of "innocent bystanders" (i.e. those holding IOU's from big banks) get mowed down in the process of "letting the big banks fail?"
To bailout Rob who is failing, you must take from Peter who is not failing. That's like trying to save the right foot by injuring the left.
It's true that the costs of bailouts tend to be dispersed among millions of productive individuals. But this just means that the public is distracted but what is easily seen, the bailed out bank, as oppose to what is more difficult to be seen, the costs. The end result is bound to be a less productive economy. One where inefficient firms that consumers are rejecting are artificially propped up at the expense of the efficient firms that consumers have approved.
As for people holding IOU's in those failing banks. Well, the FDIC in this instance would cover the vast majority of people so only a handful of people who were foolish enough to keep such large deposits in one bank would get hit. Now, I don't mean for you to conclude that the FDIC is a good thing. It's not. Absent of the FDIC and other government interventions such as the Fed, there would not have been such a crisis in the first place. Besides, people invested in stocks took a serious hit. Why should deposits be guaranteed by government and not stocks or other forms of savings.
Because in any free market or even mixed economy like that of the USA, there are always plenty of entrepreneurs who will identify business opportunities left by the failed firms. These people will jump into the market. Statements like no one has any money are just plain silly. Walmart, Microsoft, Toyota, Honda, the Chinese Government, the Emir of Dubai or any other Emirate, several hundred thousand Swiss folks, several thousand Singaporeans, etc have plenty of money and would love to jump into the business of extending loans to people.
So the whole too big to fail is simply politicians making up a policy (From the Mercantilist playbook) in order to protect their friends. And best part is that they, the politicians, can do what they do best: Scare citizens with doom and gloom predictions while appealing to their nationalist/mercantilist/ignorant prejudices.
And it works. In the South Western Ohio Area, the Congress folks who voted for the bail outs are still in Congress while the one who did not is trying to take the seat back from his replacement.
It is more important to lock up more active serial killers than less active serial killers. It is more important to let big loss making companies fail than letting small loss making companies fail. Because they are more harmful.
If a company is making a loss it means it is taking something which the consumers value more highly and transforming it into something that consumers value less highly. We are not helped by having companies. We are helped by having profit making companies and screwed by having loss making companies.
The collapse of large enterprises, especially banks, certainly imposes large negative externalities onto the rest of society.
If one wanted to "bail out" such businesses, there would have to be measures installed to prevent moral hazard.
"I'm not a fan of Murray Rothbard." -- David D. Friedman
Awesome replies.
re: The demagoguery and fear.
It's the FEAR that seems vital to address when speaking with the typical citizen, like my Democrat friend. It's the FEAR that the bank, because it's just SO DAMN BIG (i.e. its reach extends far and wide in the economy---presumably at least), surely it must be vitally devastating to let it go down.
No, because people who made the right choices would end up owning them.
In an anarcho-capitalist/free market society, the money one keeps in the bank would be backed by something of real value, e.g. gold, and we would have sound currency. The money the bank lends out would have to be backed up, so lending more than they had would not be an option because the money is actually something of real limited value ( like the gold it represents), so if no more money could just be printed to give to them, people would do what they have done historically which is have a run on the bank. The bank would be monitored and if they were giving out faulty loans and were on the road to destruction for the people entrusting in them, those who had accounts in that particular bank would have a run on the bank, get their money back, and weed bad banks out of the market. Bailouts really aren't an option unless you have artificial money and a big government.