How botched bailouts doomed companies that didn't need to fail
The road to hell is paved with bad interventions. This year’s emergency sallies into the banking system by the Fed, the Treasury, the FDIC, and the SEC have backfired. They were "intended" to ameliorate a credit crisis and to keep it from spreading. Instead they’ve inflamed the crisis into an outright panic that now has spread around the world and triggered a recession.
Conservatives may rightly object to all this government meddling in private markets on general principle. But the more salient objection is that government has botched it. The attempts to deal with failures at Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, and Wachovia were not rescues or bailouts at all—they were wipeouts, seemingly intended more to punish than to rescue. They were government takings of private property for public use—seizures of shareholder wealth in troubled firms in the name of saving the system—without the just compensation promised in the Fifth Amendment and often beyond the legal authority of the government agencies involved.
Each of these seizures was ad hoc, and most were carried out over a weekend in secret. And each was handled differently, with no apparent rhyme or reason as to which agency would be involved, which firms would be saved and which wouldn’t, or whose ox would be gored. Stockholders almost always got zeroed out. Bank depositors and insurance-policy holders were always saved. But for bondholders, commercial creditors, derivatives counterparties, and securities-account holders, it was totally arbitrary—different each time. And as often as not, these exercises had powerful unintended consequences, with the government fixing one trouble spot only to create another elsewhere in the system.
The fact that government agencies that should have been rescuers became destroyers instead—and the utter uncertainty about how and when these agencies would exercise their powers—caused investors’ confidence to collapse. Federal agencies intentionally created an incentive structure that rewarded investor behavior that would exacerbate the crisis and punished behavior that would mitigate it.
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