Thursday, April 03, 2008

Bail Out

Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chairman Christopher Cox, New York Fed President Tim Geithner, and Treasury Undersecretary Robert Steel testified today before the Senate Banking Committee.

They all stated that the bankruptcy of Bears Stearns took them by surprise even though Bears Stearns had already nearly collapsed one year ago when Bear had to bail out one of its own hedge funds, Long-Term Capital Management. This is the hedge fund that was bailed out by the Federal Reserve in 1998.

The witnesses also claimed that the Fed did not "bail out" Bear Stearns; not exactly. But rather they bailed out the broader financial industry that was somehow intricately connected to the success or failure of Bear.

Well, that is correct. Yes, Bear Stearns took it in the shorts and were made an example. But there was a bail-out.

So who specifically was bailed out? The liability that is the network of fraudulent financial connectivities. Banks and other financial institutions are hedging their bets by investing in each other in a Ponzi scheme that must collapse.

The only thing standing in the way of this collapse is the federal government. The government can postpone, seemingly indefinitely, the inevitable consequence of deception; as indeed they have done in other sectors. This is called "reassuring the markets" and it leads to restoring confidence and stability.

The government-sponsored "bail-out" by the Federal Reserve, a private bank, shields the network from disruption and mitigates the systemic liability that precipitated the original risk of industry-wide collapse, and which made the bail out necessary in the first place.

In this way, government intervention prevents the free market from operating as it should. In a free market, Bear Stearns would be in bankruptcy court, its executives and CEO would be out of a job (with a leaden parachute) and charged with fraud. Instead, Bear and all of its securities and assets are the newest acquisition issuing from J.P. Morgan's bargain-basement offer to salvage their evaporating value, whose risk-laden securities would now be backed up by guarantees from the Federal Reserve to absorb any and all losses.
In free markets, both success and failure are options. If government interventions prevent businesses, like Bear Stearns, from failing, then it is not truly a free market. As painful as it might be for Wall Street, banks, even big ones, must be allowed to fail. --Ron Paul, On Money, Inflation and Government

The other consequence of the bail-out is that there remains no incentive whatever to disconnect from the fraud. There is no move toward risk aversion. This is why these failures, and their subsequent "necessary" bail outs will continue.

Until the free market is allowed to operate, they must.


"Have You Met Fannie and Freddie?" by O. Max Gardner III, Shelby, NC, March 31, 2008.

"Paul Phenomenon" 19 Apr, 2008.

"The Fed Muddles Through a Bailout" By George Will, Sunday, April 20, 2008.


The Fed: Dealmaker, Interview with Gerald P. O'Driscoll.


Too Big To Bail: Alex Epstein, a business analyst at the Ayn Rand Institute, explains how the government's "too big to bail" policy encouraged financial institutions to make billions of dollars in bad subprime investments.