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CNN: Bankruptcy, Not Bailout, is The Right Answer

Bankruptcy, not bailout, is the right answerI usually keep my blog technical and life oriented, however today, after the “$700 billion bailout deal” did not pass, and White House is cooking up a new deal, I think it is ultra important to convey the message of top US Economists from many US Universities that “This bailout is NOT the answer to the crisis!”.

Here is the official letter that was sent to Congress on Wed Sept 24 2008 regarding the Treasury plan as outlined on that date:

To the Speaker of the House of Representatives and the President pro tempore of the Senate:

“As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come. ”

Signed (updated at 9/27/2008 6:00PM CT) by 231(!) Top US Economists – go here to see all the signatures.

Although my personal opinion is that US Government instead of just give could possibly lend money to “unfortunate” corporation with a very high interest rate, CNN published a great article by Jeffrey A. Miron, a senior lecturer in economics at Harvard University, that suggests that US should not use US taxpayers money to bailout these “unfortunate” corporations at all.

some of the quotes from the article:

“Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This “moral hazard” generates enormous distortions in an economy’s allocation of its financial resources.”

“Further, the current credit freeze is likely due to Wall Street’s hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.”

“The costs of the bailout, moreover, are almost certainly being understated. The administration’s claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.”

“The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.”