The theory behind bailouts of big financial institutions is that if they collapse they will infect other financial institutions. This will cause a cascade of contagious dominoes (to create a really ugly mixed metaphor) and will cause the economy to collapse.
Called “contagion theory” (presumably because the “domino theory” was disproved during the Cold War), it has driven almost all government responses to the never-ending financial crisis. Who has been pushing this theory? The bosses at places like Goldman Sachs, JPMorgan, etc. The very folks who would lose their shirts if those firms didn’t get bailouts. Not exactly a neutral party.
Currently some lunatic-fringe hippie types are actually saying we should risk Armageddon and let the chips fall where they may. This group is lead by a wild-eyed radical named Richard Fisher, who works as president of the Dallas Federal Reserve, clearly a socialist organization. Here’s what Fisher said in a speech at Columbia University:
It seems to me that in our desire to avoid “cascading default” and “catastrophic risk,” and in our search for “exceptional and unique solution(s),” we may well be compounding systemic risk rather than solving it. By seeking to postpone the comeuppance of investors, lenders and bank managers who made imprudent decisions, we incur the wrath of ordinary citizens and smaller entities that resent this favorable treatment, and we plant the seeds of social unrest. We also impede the ability of the market to clear or, to paraphrase Milton, allow the marketplace to distinguish “freely” those who should stand and those who should fall.
He says worries about contagion and systemic risk ”leads to an ethic that coddles survival of the fattest rather than promoting survival of the fittest, to the detriment of social welfare and economic efficiency.”
His solution is more regulation, of course. What else would a pinko-commie want?
Just as health authorities in the United States are waging a campaign against the plague of obesity, banking regulators must do the same with regard to oversized banks that undermine the nation’s financial health and are a potential threat to economic stability.
He thinks the banks shouldn’t get to use as much of their capital for investing as they want to. He wants them to set aside more of it to deal with financial problems. Further, he thinks that capital should actually have to be worth something. For some reason he has his doubts about AAA-rated securities which depend on income from financially questionable sources. I told you he was crazy.
One of Fisher’s co-conspirators in all this is Sheila Bair, the former head of the FDIC. Bair told the New York Times:
Bear Stearns was a second-tier investment bank, with — what? — around $400 billion in assets? I’m a traditionalist. Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail. So, yes, I was amazed when they saved it. I couldn’t believe it. When they told me about it, I said: “Guess what: Investment banks fail.”
Can you imagine living in a world where things like that were allowed to happen?