Professor Bainbridge...on law, politics, religion, culture & food

The bailout and conservative principles: Too many to fail

Rep. Mike Pence (R-Ind.) opposes the bailout:

Economic freedom means the freedom to succeed and the freedom to fail.

The decision to give the federal government the ability to nationalize almost every bad mortgage in America interrupts this basic truth of our free market economy.

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Before you vote, ask yourself why you came here and vote with courage and integrity to those principles.

For which Michelle Malkin thanks him.

What so-called conservatives like Malkin forget is that right-wingers have an ideology, but true conservatives have principles. As Russell Kirk once observed:

The attitude we call conservatism is sustained by a body of sentiments, rather than by a system of ideological dogmata.

It is certainly true that conservatives ought to uphold the democratic capitalist system as the best means yet found for organizing both an economy and a society. It’s also true that the process of creative destruction that lies at the heart of the capitalist system suggests that we ought to be very wary of claims that a particular firm is “too big to fail.” Indeed, as I wrote a while back:

Bailing people out repeatedly creates no incentive for people to make better decisions in the future.

It’s aptly said, however, that “When the facts change, I change my opinion. What do you do, sir?” I’ve waffled on the bailout, but the more facts I’ve learned about the current state of the financial sector, the more I’ve come to the reluctant conclusion that this is one of those projects so big and with so much at risk that government intervention is justifiable.

Too big to fail is bad public policy. But I’m persuaded that the very real prospect of too many to fail presents an entirely different question. We are faced with a situation in which a systemic credit freeze will take down not just one or two banks, but many, including not just Wall Street but also local and regional banks. In turn, as more banks fail, it will become increasingly difficult for non-financial businesses to borrow. The ripple effect could be disastrous:

During the Great Depression, such runs forced hundreds of banks to close. At the time, there was no system for protecting bank deposits - so a vast amount of money literally disappeared in the process. The nation’s money supply contracted by about a third between 1929 and 1933.

As a general proposition, a one-third decline in the money supply would, in the aggregate, lead to about a one-third decline in the prices of all goods and services. If that could happen quickly and easily, changes in the money supply would have no effect on the real economy.

But that’s not the case, of course. Businesses resist selling goods for less then they paid for them, workers resist cuts in their pay, and so on - leading to an economic depression. For this reason, most economists believe that a severe deflation should be avoided at all cost.

This is why the “freedom to fail” is a good thing when we’re talking about one firm or one industry and a nightmare when we’re talking about the entire economy.

I’d very much like people like Pence and Malkin explain the following away:

The scariest ride at Six Flags might be its debt. Its management needs to renegotiate $287.5 million in debt due next summer. “The debt is definitely weighing on the stock,” said Bill Thomas, Six Flags Inc.’s director of corporate finance. Six Flags is trading at 66 cents a share, down from $5.23 two years ago. •Aventine Renewable Energy Inc. is in a jam too. The Pekin, Ill.-based company “may not have sufficient funds to complete the construction” of two ethanol plants, debt rating agency Moody’s Corp. concluded. Aventine acknowledged it might not have enough money to meet any unanticipated needs, which could cause it to issue additional stock or bonds at a time when available cash is in short supply.

Even Fortune 500 stalwart Caterpillar Inc. faces barriers it can’t bulldoze. The heavy equipment-maker issued $1.3 billion worth of bonds last week, paying a substantially higher interest rate than it did for bonds issued last month.

These examples are among dozens playing out across the U.S. as companies far removed from banking deal with the financial crisis. As a consequence of investment banks and homeowners gorging too much on debt, businesses and entrepreneurs now have access to too little. Without a steady flow of cash, companies may have to cut back on everything from research and development to maintenance and eventually could shut down, triggering mass unemployment.

“The capital markets are already challenged,” said Larry Tabb, founder of financial research firm Tabb Group. “If bank credit stops, the result is borrowing stops; credit cards stop; mortgages stop; building stops; business stops; jobs evaporate; and we head straight into a U.S, if not a global, recession like one that we have not seen since the Great Depression.”

In sum, there are some principles worth fighting and dying for. But the “freedom to fail” damn sure isn’t one of them. I’m as much a limited government guy as the next fellow, but let’s not pretend that we live in some libertarian utopia in which the state has no role in the market. As Edmund Burke once observed, albeit in a radically different context, there is “a limit at which forbearance ceases to be a virtue.” At that limit, the state properly steps in. When the risk of the entire economy going down the tubes is as high as it is at the moment, preservation of ordered liberty requires state intervention.