Economists Have Abandoned Principle

The title is from Oliver Hart and Luigi Zingales writing in the WSJ:

Practically every day the government launches a massively expensive new
initiative to solve the problems that the last day’s initiative did
not. It is hard to discern any principles behind these actions. The
lack of a coherent strategy has increased uncertainty and undermined
the public’s perception of the government’s competence and

By principle, Hart and Zingales mean economic principle such as intervening only when market failure in the technical sense is an issue.  Bankruptcy, for example, is not the end of the world (As you may recall I have been pushing the idea of speed bankruptcy for which the FDIC has developed significant expertise.)  For example,

…what would have been so bad about letting Bear Stearns, AIG and
Citigroup (and in the future, General Motors) go into receivership or
Chapter 11 bankruptcy? One argument often made is that these
institutions had huge numbers of complicated claims, and that the
bankruptcy of any one of them would have led to contagion and systemic
failure, causing scores of further bankruptcies…

…This argument has some validity, but it suggests that the best way to
proceed is to help third parties rather than the distressed company
itself. In other words, instead of bailing out AIG and its creditors,
it would have been better for the government to guarantee AIG’s
obligations to J.P. Morgan and those who bought insurance from AIG.
Such an action would have nipped the contagion in the bud, probably at
much smaller cost to taxpayers than the cost of bailing out the whole
of AIG. It would also have saved the government from having to take a
position on AIG’s viability as a business, which could have been left
to a bankruptcy court. Finally, it would have minimized concerns about
moral hazard. AIG may be responsible for its financial problems, but
the culpability of those who do business with AIG is less clear, and so
helping them out does not reward bad behavior.


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