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Thursday, January 28, 2010

Bailout Nation: a review

I just finished reading Barry Ritholtz’s book titled Bailout Nation. It is an investigation, one of the many such books, into the causes of the credit crises in late 2008. As the title suggests the book was primarily concerned with the moral hazard that was caused not just by the recent bailouts but government bailouts going back to the 1970s. This is an interesting read from a non-libertarian perspective interested in issues of moral hazard and unintended consequences.
There are three themes that I’ve identified throughout the book:

1. Allan Greenspan and the Federal Reserve deserve a great deal of the blame for the credit crisis.

Mr. Ritholtz points to Mr. Greenspan’s interference in the market on several occasions, in particular he describes in detail the 1987 market crash and the dot.com burst of the early 2000s. He points out that Mr. Greenspan’s policy goals were not aimed at stabilizing the economy, the job that Mr. Rtholtz feels is appropriate for the Federal Reserve, but in saving the collective asses of Wall Street Traders.

It was pointed out that Mr. Greenspan thought of himself as a free market ideologue but that he constantly interfered with the market. Both Mr. Ritholtz and I are a little confused how a man who is called the "Maestro" of the economy could be a Free Marketer. Mr. Ritholtz had the decency to express his sympathy to the ghost of Ayn Rand.

2. The CEOs of the large financial institutions were incompetent.

He seems to get very passionate on this point. He proclaims the idiocy of lending money without checking the ability of the recipient to repay the money. This is hard to argue against. It is clearly true that these corporations acted foolishly, which is why they deserve to fall. Mr. Ritholtz thinks that is why they deserve to be regulated, which brings me to the next theme.

3. The free market has failed to regulate itself.

Mr. Rtholtz describes the deregulation and claims that they made the crisis far worse. He moves back and forth on if the deregulation itself was a cause of the crisis. In the first half of the book he points exclusively to bailouts as the cause. Large firms knew that they could take massive risks because tax payer money or the Federal Reserve would likely rescue them. In the second half he says that deregulation allowed firms to do whatever they wanted which led to chaos. It is bizarre that someone so thoughtful seems to have failed to connect these two facts. Deregulation may have allowed them to take greater risks, but government action encouraged them to do so. How is this a failure to self regulate?

It is particularly puzzling that he seems to have missed this in his analyses because in an “Intermezzo” Mr. Ritholtz makes the explicit counter argument to his assertion that markets have failed to self regulate:

“As a nation we have a choice to make: Either we place some reasonable regulations upon the banks and investment houses or we allow the vagaries of the free markets to punish those who trade with, or place their assets in, the wrong institution...There is no middle ground; it is an either-or choice. But for God’s sake, we cannot suffer the worst of both worlds...”

The credit crises was not so much a result of the market’s failure to self regulate as it was a result of the government not allowing the market to self regulate. For the government to self regulate firms have to be allowed to suffer or die.

Over all, though there are several points that Mr. Ritholtz made that I disagree with, Bailout Nation is an easy to read, generally well thought out, and interesting book.

Posted by Hugh MacIntyre on January 28, 2010 | Permalink


The problem is not deregulation or intervention. We are a nation of laws in theory. When some entity creates a financial instrument then sells it to unsuspecting clients without FAIRLY disclosing the inherent risks, it is FRAUD. It is especially egregious when Ratings Agencies collude in the fraud by giving falsely optimistic ratings for the instruments.

It was fraud and misrepresentation that caused the problem. The only lasting solution is to prosecute all involved and severely penalise those found guilty.

This will stand as a warning for the future.

Posted by: Bill MacLean | 2010-01-28 7:14:29 AM

Hugh, good post. Not only shoudl we deregulate but we should also do away with such laws as insider trading, which in the end, hurt average investors the most.

Posted by: TM | 2010-01-28 8:56:25 AM

We now have two governing avenues to travel. One is the diminishing traditional “admire and applaud” system, the Ayn Rand side, and the other, from the Old World, is the growing “envy and punish” system. President Obama favors “envy and punish” and pursues legal means of justifying them both, beyond the limits of our Constitution, which is based upon defending the “admire and applaud” concept. The recent vote in Oregon to tax the small business person out of existence reflects the Obama side of governance, promoting an Old World mercantilist model of government partnering with large business to act as one, leaving the individual pebble dropper out of the loop. Claysamerica.com.

Posted by: clay barham | 2010-01-28 9:05:22 AM

Clay is such a douche, like his side isn't far more disenguous, and far more dangerous when you consider everything in his strategy amounts to short term gains at the cost of a future. Clay and the republicans will most likely destroy everything before they would ever make any concessions in regards to making things better.
Nobody has forgotten how that sides idelogy has placed us all in peril, and doing business at the expense of everything will doom the future, how could it not?

Posted by: Howard Zinn dead at 87 | 2010-01-28 12:21:37 PM

H.Z. dead at 87, perhaps you are part of the living-impaired. The current Democrat Party believes in and practises bleeding to death productive citizens while rewarding the non-productive ones. In any case one has to wonder how much longer China and other foreign powers will agree to bail out the U.S.A., for that is what it boils down to.

Bill, I do not disagree with your comments except that it was the American federal government that forced financial institutions to make the risky loans in the first place.

Posted by: Alain | 2010-01-28 6:09:26 PM

"American federal government that forced financial institutions to make the risky loans in the first place."

Posted by: Alain | 2010-01-28 6:09:26 PM

Exactly Alain. Nothing like promising a chicken in every pot to guarantee votes. I still remember seeing the ads, " buy this $400.000 house for only $899. per month" and wondering what kind of magic was this ?. The magic was Freddie and Fanny just following government directives.
Work at MacDonalds ??. Why should'nt you own that $200.000 house ??.

Who in their right mind could'nt see that train jumping the tracks.

Posted by: peterj | 2010-01-28 9:01:58 PM

"it was the American federal government that forced financial institutions to make the risky loans in the first place."

Alain. I'm assuming you're referring to the CRA. Your statement is perfectly correct for those types of loans. But the banks made tons of bad loans to all types of people from all income ranges and ethnicities. No one put a gun to their heads. The basic fact is that these bankers knew that they could make those loans and have: 1) F&F to bank them up; 2) the FED to hand them free money if things went sour; and 3) the U.S. gov't to bail them out. The bankers love this arrangement and love making loans under it. Don't think for a second that they are some kind of victim here.

Posted by: Charles | 2010-01-29 5:19:21 AM

Charles, yes I was. I also suggest that set a certain trend or mindset within the American banking community and therefore contributed to even more bad loans. Of course I cannot prove it, but I find it probable considering human nature.

Posted by: Alain | 2010-01-29 11:59:42 AM


You can't prove an economic theory. You have to first make sure that your theory is logical. Then you look and see if the theory fits the facts.

Moral hazard. Right now, in Canada, we are getting the same type of phenomenon. We've inflated the money supply - so bankers have tons of extra reserves. The CMHC is guaranteeing billions of $ of securitizations. The bankers simply do not care about loan quality anymore because they know that the taxpayer is on the hook. How do I know? I've had CEO's and CFO's come out and tell me. It's public knowledge as well. These guys brag about it on their quarterly earnings calls.

This whole culture of taking insane risks started much longer than you're implying though. It started with suspension of specie payments in the 19th century, continued when central banks were created, and now we've got governments guaranteeing their loans and directly bailing them out. It's just going to get worse.

Posted by: Charles | 2010-01-29 3:06:38 PM

Charles, it seems to me that we are in agreement. My point was that if the financial community think the government will bail them out, they will be more willing to accept bad or risky loans.

Posted by: Alain | 2010-01-29 6:24:31 PM

"more willing to accept bad or risky loans."

Posted by: Alain | 2010-01-29 6:24:31 PM

The sad part is that they did not even see these loans as risky. After all ...real estate would continue to rise and the assets would continue to grow in value, so even when the asset was repossessed there was still a profit to be made. In most cases they knew that when the mortgage rates reset, the poor bastards would lose their home. For the greedy pricks that pulled this off there was no downside. The government bailout proved them right.
This whole misguided scheme was endorsed by the government and taken full advantage of by the sharks in finance without anyone being aware of the consequences when tens of thousands mortgages reset and the market was suddenly flooded with umpteen thousand vacant homes.

I guess all I am trying to say is that Alain is absolutely right...as long as government bails out these greedy bastards they will climb over as many bodies as necessary to reward themselves.

To hell with the consequences.

Posted by: peterj | 2010-01-29 11:07:15 PM


It's much worse than that I'm afraid. These guys have a fiduciary duty to their shareholders to maximize returns for the smallest risk possible. In other words, they'd be fired if they did not take advantage of this.

The only solution is for the gov't to get out of banking. Completely. That means no more fractional reserve banking, central banks, F&F, CRA, CMHC, deposit insurance, suspension of payments, OSFI, etc. etc. etc.

Posted by: Charles | 2010-01-31 11:44:35 AM

"The only solution is for the gov't to get out of banking. Completely. That means no more fractional reserve banking, central banks, F&F, CRA, CMHC, deposit insurance, suspension of payments, OSFI, etc. etc. etc."

Posted by: Charles | 2010-01-31 11:44:35 AM

I could agree completely with this if people were capable of looking after their own interests. I would venture that the vast majority are not and therefore oversight by government is neccessary. Elimination of control would mean that the Earl jones and Madoffs would rule without consequenses. (Actually they already seem to) As the government spends billions of our dollars every year , the last thing they would do is relinquish control to other thieves.
When they reach into our pockets for never ending increases in taxation they need a place to store that money...henceforth..the national banks. As you know, this subject has many layers, but the government will keep a tight grip on all of them.

Posted by: peterj | 2010-01-31 9:58:55 PM

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