What if Bailouts ARE Inevitable?

In an earlier post, I wrote that Paul Krugman is basing a lot of his policy analysis upon the belief that future Wall Street bailouts are inevitable. Given what has transpired in the past few decades, I would say that he very well might have a point.

Thus, by beginning with the assumption that there will be bailouts, Krugman then mentally reconstructs a financial system that will never need to be bailed out, or where bailouts where be rare. How would such a system be organized, and what would it do?

While Krugman has not put out a hugely-detailed plan, some things clearly are in view. First, all of the financial organizations, including banks and the financial houses such a Goldman-Sachs, would be strictly regulated by the SEC. (However, the SEC currently regulates these institutions, so my guess is that what he proposes is that the SEC be given more power than it currently has, the idea being that more regulation will keep meltdowns from occurring.)

On the other hand, as noted in earlier posts, Krugman also favors the Fed aggressively lowering interest rates to below-market levels, which not only would be inflationary but would discourage savings. (Of course, Krugman, being a good Keynesian, attacks savings as lowering "aggregate demand.") So, we have the prospect of the Fed opening the money spigots and the SEC trying to route it to "safe" investments.

In a speech last year, Peter Schiff pointed out that depending upon the SEC to vet all firms actually creates larger problems because market participants are not as careful about their choices. He gave the example of con artist Bernie Madoff, noting that had people not been fooled by the lack of SEC oversight, the market would have flushed out Madoff long before his empire fell.

I think Schiff is on to something here. Krugman seems to believe that since bailouts are inevitable, we need a very strict SEC to vet everything, and a Fed to turn up the crank, and somehow that will give us prosperity -- and will keep bailouts from ever being reality. All that is needed, he claims, is for regulators to be "smart" and "believe in government."

What Krugman does not say is that having the federal bureaucracy determine the direction of investing will be disastrous. Do we really want the risk-averse, bureaucratic culture to run our economy, because THAT is what would happen.

I have a better idea. Require banks to hold 100 percent reserves and tell all financial firms that if they fail, they fail on their own. Unfortunately, our current political culture favors bailouts, and if that culture continues, we are going to find that "finance" will mean nothing more than borrowing and paying off government debt.