Playing with our money

by Russ Roberts on November 25, 2009

in Financial Markets

Seekingexports comments on this post:

Mr. Roberts, when you wrote “playing with our money” did you mean TARP funds or the funds from institutional investors such as government employee 401B funds (ie. U of V retirement)?

Even though I don’t think that Lehman and Bear Stearns received rescue funds I think the ones who did, like B of A or Wells Fargo, may be making risky trades now with taxpayer money. They are too big to fail and they know it.

What I meant was too subtle. The people who lent Bear and Lehman money were playing with taxpayer money. Not literally but eventually it was the same thing.

Suppose I lend you money to do something incredibly risky that will make money for a while and then will either be OK or collapse. As a lender, this is really stupidĀ  because I don’t share in the upside. I have a fixed upside–the interest I earn, and I risk being wiped out. So I normally wouldn’t do that. But if the guy in the corner, Uncle Sam tells me he’ll cover my losses, then I lend you the money, knowing that I can’t lose. You take my money and pay yourself a really high salary in the meanwhile out of my funds and the short-run returns.

If the investment collapses and you go bankrupt, you shrug and count the money you’ve been paying yourself in salary. I shrug because the government pays me the money you owed me. The taxpayer is left holding the bag. Who was really financing the investment? It wasn’t me. It was the taxpayer. I was effectively using their money when I made the loan.

It is the creditors who get bailed out. That’s what matters. Bear Stearns didn’t get bailed out. Their creditors did. AIG did get bailed out. But what’s important is that their creditors did. The only creditors that didn’t get bailed out were Lehman. As far as I can tell, their creditors were mostly Asian banks. Not enough political clout. No cronies there.

The cronies in crony capitalism are the creditors and the people who make money along the way borrowing the money. That includes Bear and Lehman execs and Goldman execs and many more.

If creditors know they’ll be bailed out, aggressive investors borrow from them, leveraging their returns and paying themselves a lot of money along the way, justified by the short-term profits.

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