“Bailouts In Lieu of Bankruptcy”

Dartmouth’s Andrew Samwick, a former member of the President’s Council of Economic Advisers, wrote about the bailout of the financial sector that is now in progress on the web site Capital Gains and Games:

In brief, the government has three places where it can intervene when there is a looming bankruptcy:

1. It can give the firm’s customers more money.
2. It can give the firm more money.
3. It can give money to firms that are compromised when the distressed firm fails.

We can think of #1 as foreclosure relief to households unable to pay their mortgages. I refer to #2 as “bailout in lieu of bankruptcy.” We can think of #3 as the Fed’s interventions to make credit more widely available.

My main point continues to be that “bailout in lieu of bankruptcy” substitutes a reduction in taxpayers’ disposable income for a reduction in the claims of non-insured debtholders of the distressed firm or bank. I see no justification for this. It is special interest politics in one of its worst forms. We have procedures for bankruptcy for both financial and non-financial firms. We should use them, and then consider some variant of #3 in the most extreme cases.

If you follow the link in Andrew’s post to his Power Point presentation titled “The Right Way To Do Stimulus and Bailouts,” there is a great deal more interesting information and analysis. I like these provocative observations:

* I take a very dim view of the word “stimulus.” It seems to be a code word for wasting money.

* Even more than in a boom, this is no time to waste money. The lean economic times argue for more vigilance against waste, not less.

* Which would you prefer? A lousy economy with a low debt burden, or a lousy economy with a high debt burden?

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