What should we now think about the bailout?

One very loyal, and libertarian, MR reader writes to me:

But I was actually somewhat (not altogether) surprised by your support for the bailout package.  So let me ask you again, what would cause you to disagree with yourself?  I guess I’m asking because I can’t provide good answers to the following questions: What information do policymakers have to get it right? And what incentive do they have to get it right? Therefore, I don’t see how they will get it right, and are more likely to do long and short run harm.

In my view the real bailout is the existence of the FDIC which, like it or not, is not a commitment we cannot walk away from.  Had nothing been done, the required FDIC bailout of bank depositors would have been enormous, given frozen interbank credit markets plus a certain level of panic.  So in reality I favored a smaller bailout than did most of the "purer" libertarians, although MR commentators rarely frame it as such.   

A combination of bank recapitalization (which I was first skeptical about and thus have changed my mind on) and a greater emphasis on an "identify and isolate the bad banks" approach was the right bailout to do, not to allocate $700 billion for TARP.  I agree with everything Arnold writes in this post, but still in my view "doing nothing" wasn’t really an option, again if only because of the preexisting FDIC commitment, not to mention the disaster associated with a plummeting money supply. 

Now that financial confidence is partially restored, we can hope that the Obama administration redoes the deal.  But the money is being committed rapidly and the demands of the interest groups are piling up, so I hardly expect much ex post improvement.

As for changing one’s mind, it is hard to get real evidence on this since we won’t be running the counterfactual of no bailout.  If I learned that interbank exposure and counterparty credit risk was much less than I had thought, and that the number of potentially insolvent banks was quite small, then yes I would change my mind and favor no bailout at all.  But I haven’t learned that.


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