What’s worse than an apocalypse?

by Russ Roberts on December 7, 2011

in Crony Capitalism, Financial Markets, Uncategorized

On my exercise bike at the gym the other day, I caught a snippet of the Stuart Varney Show. Three guests were discussing the European crisis. John Stossel argued for letting market forces work–if I remember correctly, he wanted those banks that had lent money to Greece and Italy and Spain to bear costs, possibly severe costs like losing their money. One of the guests (I don’t know who it was) strongly disagreed. His argument was that Stossel’s solution would lead to the apocalypse. That was his argument. We risked the end of civilization–banks could go broke leading to a depression and then we’d all be worse off. Varney agreed. Stossel’s idea of market discipline was simply too dangerous.

Stossel gave a good answer. He said but what if we get the apocalypse anyway? Maybe all we’re doing is kicking the can down the road and making the reckoning even worse than it otherwise would be. His answer is made more powerful by recent history. In 2008, we rescued the creditors relentlessly that helped pave the way for this crisis. What will the next one look like?

I have a different problem with the apocalypse argument. How do you know if it’s true? Where’s the evidence that letting banks lose some, or most or even all of the money they unwisely lent or invested in bonds is going to lead to a disaster? Where are the data that make this claim credible other than a bald assertion?

But I have an even bigger problem with the apocalypse argument. If the threat of banks taking a haircut risks the apocalypse then we may as well admit the game is over. Just give the banks our wallets and checkbooks and go home. It’s the end of capitalism and the end of democracy. I’d prefer an apocalypse.

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{ 66 comments }

Methinks1776 December 7, 2011 at 12:22 am

Me too.

Chucklehead December 7, 2011 at 2:15 am

The problem with Stossel’s solution is it is a solution. Never waste a crisis.

Invisible Backhand December 7, 2011 at 9:57 am

I feel the same way about all the money we waste on Israel.

SmoledMan December 7, 2011 at 5:15 pm

Interesting you pick out Israel. Scratch a leftist, you usually find an antisemite.

Greg Webb December 7, 2011 at 11:17 pm

And, you always find an idiot.

Mr. Drysdale December 8, 2011 at 9:22 am

It is amazing that if you disagree with financial support for Israel you are automatically an antisemite!

Mueller December 8, 2011 at 9:32 am

But why is it always Israel? We give a lot of other countries a buttload of cash and have even less to show for it. Egypt and Pakistan come to mind.

Dave December 7, 2011 at 12:33 am

I have little doubt that letting those banks all fail at once would lead to a steep recession. It would likely lead to a collapse in the money supply similar to the Great Depression (because of collapsing credit). However, I think you just trade off some depth for some breadth. In the US, we have many zombie banks that are only technically solvent because the authorities relaxed the mark to market rules on their assets. This is why many of them trade below their stated asset values. I think the US recession would’ve been even steeper had we let them fail, but instead we have this prolonged malaise. At least if you let market forces work and let the banks fail, rebuilding* can start sooner and we can get on with our lives.

* by rebuilding, I mean something along the lines of Kling’s PSST story: establishing new sustainable patterns of trade.

Floccina December 7, 2011 at 10:19 am

I agree with this:

“I think you just trade off some depth for some breadth. ”

It has been 3 years since the financial crisis and unemployment is still 9%. The recovery is very weak. If you let the banks fail and even if we had a very sharp deflation especially in housing we might be well into a very strong recovery by now. A sharp enough deflation might unstick wages.

JoshINHB December 7, 2011 at 11:09 pm

Ironically, we have had sharp deflation in housing with more to come.

Pingry December 7, 2011 at 6:47 pm

Right! And strangely enough, Russ didn’t know the difference between currency and credit in his recent podcast with Tyler Cowen.

He wanted the banks to fail, ex-ante, then have the Fed (or whatever central bank) come in, ex-post, and start doling out currency as that would somehow make up for broken financial markets.

–Pingry

Jeremy December 7, 2011 at 12:36 am

I’m a libertarian and I say, screw the banks. They got themselves into this mess by overleveraging and making bad gambles, then using the government–i.e., taxpayers–to backstop their losses so they wouldn’t lose any profit. And right now, at least in the states, they’re so full of cash they don’t have anything to do with it.

Screw the whole FIRE industry. At this point, it’s nothing more than a carefully crafted charade designed to make our money worthless and establish an elite cadre to run our lives. I hate to say it, but I think that, on this point, those radical crazy leftists actually had something worth saying.

Methinks1776 December 7, 2011 at 7:59 am

Yes, but what the left has to say is that the wrong people are bobbing us, making money worthless and establishing an elite to run our lives and there’s not enough of any of it. I don’t find any comfort in that.

Jeremy December 7, 2011 at 11:15 am

I was referring mostly to those dystopian cyberpunk novels where the corporations run everything. A lot on the left really think that our modern world is a corporatocracy…and I’m not terribly inclined to disprove them, at this point.

Yergit Abrav December 7, 2011 at 8:58 am

Totally agree. But we have to be willing to let some wealthy depositors, and other wealthy creditors of banks also take a loss. That, is what the politicians are referring to as the apocolypse.

The number of banks that will not pay out the middle class depositors even in the worst case scenarios is miniscule as all the other creditors will get stiffed first…

So, this is about protecting the rich and powerful from the consequences of bank failure and of course protecting the bankers themselves.

Jeremy December 7, 2011 at 11:14 am

Let the wealthy take the loss. It was their gamble.

Yergit Abrav December 7, 2011 at 12:22 pm

Yep, agreed. bring it on.

Scott G December 7, 2011 at 12:51 am

Count me in for the apocalypse party. What can I bring? Are kids welcome to come?

Chucklehead December 7, 2011 at 2:13 am

Who is in charge of the punchbowl? Bernanke or Greenspan?

GAAPrulesIFRSdrools December 7, 2011 at 11:03 am

To go to a “party” with those two.. the punch would have to follow a recipe from Jonestown

Chucklehead December 7, 2011 at 2:10 am

The solution to everything is that fiat global currency called SDR’s. These can be generated as needed dy the IMF, and not have to rely on any country to have the pesky will of the people. What could possibly go wrong?

GOT GOLD?

Ken December 7, 2011 at 2:36 pm

Got copper, brass, and lead? ;)

Doc Merlin December 7, 2011 at 2:45 am

“But I have an even bigger problem with the apocalypse argument. If the threat of banks taking a haircut risks the apocalypse then we may as well admit the game is over. Just give the banks our wallets and checkbooks and go home. It’s the end of capitalism and the end of democracy. I’d prefer an apocalypse.”

This is what happens when you have a central bank + a fiat money system. I really don’t see a way around it, eventually you will make the entire financial system government controlled. This will either happen by the banks taking over the government or the government taking over the banks.

Chucklehead December 7, 2011 at 3:12 am

If we could Teflon® coat the wages, then we wouldn’t need a central bank to inflate the currency. Why hasn’t Krugman called for the Martians to attack earth with Teflon®.

Salt Water Economist December 7, 2011 at 5:52 am

Seriously Russ, grow up. Who would ever listen to John Stossel, who would say or do anything to gain one more viewer. The man has no integrity, whatsover.

To suggest that either deflation or liquidation are ever the answer is madness and you know it.

For starters, because idle plants deteriorate and idle people loose their skills, deflation or liquidation make us less productive and limit future growth so they are never a sensible solution to any thing.

And, we tried both once, from 1929 to 1933, or have you forgotten?

Banks do not make bad loans on purpose. In fact, you know that all they ever do is attempt to make the least bad loan or investment possible. Banks have no choice about keeping assets idle for they pay interest on their deposits and their own bonds.

In sum, be honest about the causes of the problems in Europe. It is the Euro itself, not the banks or their loans and bonds. The system cannot be made to work. Austerity in the South will only create more austerity; it cannot create economic activity or growth (who during austerity would choose to locate or start a business in the South?).

The Euro currency union will, over time, result in more and more economic activity moving to the German. Economic growth and activity, even in Germany, is highly irregular. (The same is true in the United States, where workers in the Valley are three times or more productive than workers in Kentucky, because of the same forces.)

You conclude, “It’s the end of capitalism …?” Have you finally found your senses and come to realize that Marx was right? What you seem to object to is that finance will have your “wallets and checkbooks.” Marx said such.

vidyohs December 7, 2011 at 6:17 am

“Banks do not make bad loans on purpose. In fact, you know that all they ever do is attempt to make the least bad loan or investment possible. “

Actually they do when they have been reassured by the government that the American taxpayer will cover their ass when the loans go bad.

And, I hope you don’t deny that that was the case.

Salt Water Economist December 7, 2011 at 2:32 pm

vidyohs

reading you posts it is plain you do not understand banking.

banks work exactly opposite of the way you seem to think. They grow their liability side, their deposits, as large as possible. Then they hope and pray that there is some line of business where they can make fees or earn interest sufficient to pay what has been promised the depositors.

The rate of growth is limited by how quickly reserves must be added for new deposits.

Bank behavior is not based on any expectation of a bailout.

Because the competition for depositors is so great, banks will engage in almost any activity that offers the promise of being able to pay the interest promised to depositors. For that reason, banks have tremendous internal governance problems trying to retain and control their loan and investment officers. This has lead to compensation schemes that are absurd. In turn, these loan and investment officers have incentives to make really risky bets, not because of tax payer bailouts, but because they can make so much if the bet hits.

It is compensation that makes Banks behave as they do, not the prospect of tax payer assistance.

vidyohs December 7, 2011 at 7:04 pm

Banks are business and I understand business very well, very very well. Without government interference in the market, banking included, you would be right, not bank would intentionally make a bad loan, or one they had good reason to believe would be bad. That is why “in the day” you not only applied for a loan (providing references or credit history), you likely faced an interview with a concerned bank officer before approval was offered.

But, we watched banks make bad loans right through the 70s, 80s, 90s, and the 2000s, all because of the arm twisting in the early years and always the knowledge that government was covering their ass.

Go ahead, troll, deny that.

Russ Roberts December 7, 2011 at 8:03 am

Ah, welcome back Mr Ad Hominem.

John Stossel’s argument is wrong because he is John Stossel. And you? You are right because of one data point. You make a great shill for the banks. Congrats.

Salt Water Economist December 7, 2011 at 6:23 pm

Russ,

Cut your crap, especially about the banks

Unlike you, I support breaking them up and keeping their size reduced, so that they are no longer too big to fail.

You bitch and moan about the banks but oppose doing anything about them, except letting them go off like bombs destroying everything, so that you can have something to continue to bitch and moan about, I guess.

Never forget, I have the trump card–data point—in my hand. We tried austerity and liquidation from 1929 to 1933. It doesn’t work.

When you have one data point to your favor, show your card. Until then, why not do the public a service and zip it.

BTW, what do you complain about me being a troll but not all the racists that lurk here?

Richard Stands December 8, 2011 at 12:03 am

Yep, like all those other firms that went through bankruptcy restructuring and went off like bombs:

General Motors
American Airlines
Heinz
United Airlines
Disney

Boom. Gone. Never to be heard from again. Every haircut is a decapitation.

Jon Murphy December 7, 2011 at 8:35 am

Sheathe your swords, gentlemen. This illusion is not worth our time. We’ve better things to be doing then chasing windmills pretending to be giants.

Yergit Abrav December 7, 2011 at 9:02 am

Marx did a great job at manufacturing useless idiots, I will give you that.

Yergit Abrav December 7, 2011 at 9:03 am

I actually meant useful idiots, useless idiots is actually an ad hominem that was not intended

anthonyl December 7, 2011 at 10:29 am

I listen to John! He’s a TV reporter dude he never claims to be anything else! So why are you so down on an idea based entirely on what you think of a person. I would def. characterize Rivera that way because that’s how Rivera presents himself, but Stosel is much more thoughtful.
Deflation and liquidation are the answers and that is why we don’t go there our leaders, for some reason, want to stay in crisis mode.
That last comment about Marx being right tells me you are very misinformed about what human tragedy his ideas have precipitated. I have never read Marx because I feel it would be a waste of time but what is it that you think he was right about? His labor theory was was blown up long ago. Now it is people that belive in Marx that are letting the banks have our wallets.

JoshINHB December 7, 2011 at 11:18 pm

Marx’s scribblings are a great cure for insomnia.

Josh S December 7, 2011 at 11:20 am

No one loses money on purpose. Therefore, no corporation should be allowed to lose money, but be guaranteed profits by the taxpayer.

Randy December 7, 2011 at 7:27 am

I have a hard time imagining the banking system “failing”. I picture instead a case of current bank management failing, the “troubled assets” being abandoned, and the still valuable assets being bought up for something close to their present value. That is, the political system is not rescuing the banking system. It is propping up failed cronies.

jjoxman December 7, 2011 at 7:49 am

Isn’t Iceland the guide here? The Icelandic government did not bail out the banks, and they have survived much better than the countries, like Ireland, that did bail out their banks.

Jeremy December 7, 2011 at 11:26 am

Exactly. Unfortunately, US and continental European political leaders do not have the guts, nor the insight, to follow the Icelandic model and just tell the banks to go to hell.

yet another Dave December 7, 2011 at 11:43 am

I don’t think its an absence of guts or insight, more likely simple cronyism. See Randy’s comment above (December 7, 2011 at 7:27 am)

Paul Marks December 7, 2011 at 7:57 am

Stuart Varney is just terrible.

He is exaxctly the sort of “friend” that Bastiat warned about almost two centuries ago – someone who opposes socialism for the poor (opposes the government giving the poor money and benefits), but supports it for the rich (especially the banks). Such a “friend” of free enterprise is exactly what the socialists love – as they can point to his hypocrisy.

As for his ideology (for Stuart Varney does have one) it is that this is a “fiaance economy” totally dependent on the antics of Wall Street (and so on) so anything (anything at all) is better than than letting the Wall Street crowd (and their kin in other banking centrers) go bankrupt. He even supported TARP (and the rest of the subsidy orgy) in 2008/9, and will talk (with a straight face) about how the banks have “paid back the money” (without mentioning that they have done this with their profits from other government loans – thanks to the Federal Reserve and the Treasury).

Mr Varney totally fails to understand that there can be no such thing as a “finance economy” – that, in real life, loans must be from REAL SAVINGS and that the only true “economy” is that which makes actual products (not book keeping tricks to create credit from NOTHING).

I dread the day when Neil Cavuto goes and Varney takes over (if he does). Neil Cauto is no Austrian School economist – but he does have good instincts. The instincts of Stuart Varney are so bad he might as well be working for the “Financial Times” newspaper or the “Economist” magazine – or some other leftist outlet.

As for the “apocalypse” (i.e. economic bankruptcy and breakdown) OF COURSE it is going to happen (with an economy this distorted it could hardly be avoided even if everyone was working hard on rolling back government – and, in fact, statism is getting worse every day).

But handing out endless subsidies (sweetheart “loans” and so on) to the banks (the Varney religion) is not going to prevent it – actually it will just make it even worse.

MWG December 7, 2011 at 12:47 pm

“He is exaxctly the sort of “friend” that Bastiat warned about almost two centuries ago – someone who opposes socialism for the poor (opposes the government giving the poor money and benefits), but supports it for the rich (especially the banks). Such a “friend” of free enterprise is exactly what the socialists love – as they can point to his hypocrisy.”

Excellent comment.

There are many like this on ‘the right’. It’s what separates those who are pro business from those who are pro market.

J Cross December 7, 2011 at 8:04 am

Penn and Teller make essentially the same post-apocolyptic argument in their BullS**t episode from 14 February 2003 (entitled something like “The End of the World”). Essentially the point is that they interview a bunch of end of the world survivalist types and come to the conclusion that if the end of the world is anything like these guys think it will be then Penn and Teller would rather be dead. (They also come to the conclusion that there’s no reason to believe that the end of the world is ever going to be upon us.)

It’s similar with people who maintain that technology is overtaking our deeply personal lives when those people say things like: what happens if the Internet goes down? Well, if the Internet really stops working we’ve probably got a lot bigger problems to deal with than posting a picture of what we had for dinner last night on Facebook.

Mueller December 8, 2011 at 9:23 am

Well, if the Internet really stops working we’ve probably got a lot bigger problems to deal with than posting a picture of what we had for dinner last night on Facebook.

Damn right. My wife will make me patch that hole in the drywall.

Tom Kelly December 7, 2011 at 9:17 am

So what if the money/credit/debt disappears?

What are we left with? The same people and physical assets we had before.

With the same wants and needs and ability to provide for them.

Money is not the economy. People and physical assets are. We will come up with a new system creatively and spontaneously.

There will be pain, but no apocalypse.

Captain Profit December 7, 2011 at 11:19 am

Relatedly, I saw Robert Gibbs on the Today Show this morning, explaining that without the auto bailout, a million more people would be out of work. The problem with a statement like that is that the market for automobiles that GM services wouldn’t simply go away just because GM went away.

Salt Water Economist December 7, 2011 at 6:29 pm

Russ

Don’t these comments warrant being labeled a troll.

Josh S December 7, 2011 at 11:30 am

“I have a different problem with the apocalypse argument. How do you know if it’s true? Where’s the evidence that letting banks lose some, or most or even all of the money they unwisely lent or invested in bonds is going to lead to a disaster? Where are the data that make this claim credible other than a bald assertion?”

Ben Bernanke claims that the reason the Great Depression happened is that the Fed allowed the banks to fail. I do not personally find his argument convincing, and instead find it far more convincing that Hoover’s and FDR’s interventions prolonged the disaster, but that’s the claim, and it’s based on an interpretation of the evidence, so that’s whom you’ve got to respond to. I mean, Bernanke’s study of the Depression is THE driver behind bank bailout policy recently, so that’s where you need to direct your critique.

Jeff Neal December 7, 2011 at 5:01 pm

To make your point even better . . . yeah, Ben, the depression was bad, and even if you’re right that letting the banks fail is what caused it, ummmm, the country survived. Apocalypse didn’t happen, unless you have a different definition of the word than I do.

Salt Water Economist December 7, 2011 at 6:32 pm

Apocalypse didn’t happen . . .

What about the hopes and dreams of millions of people that was lost

What about that little event that cost 60 or 80 million lives, called WWII, that had its genesis in the World Wide Great Depression.

Jon Murphy December 7, 2011 at 6:39 pm

WWII has roots in WWI.

Jon Murphy December 8, 2011 at 8:51 am

Actually, if you want to be really technical, WWII has it’s roots in the Franco-Prussian War of 1870.

vidyohs December 7, 2011 at 6:58 pm

Seems you not only don’t understand business, but you don’t know history either.

Jon’s right, WWI impoverished Germany financially and spiritually with reparations and humiliation. It opened the door for a demagogue like Hitler, and with Hitler came WWII.

g-dub December 7, 2011 at 10:51 pm

What about that little event that cost 60 or 80 million lives, called WWII, that had its genesis in the World Wide Great Depression.

Wrong.

I mean, wrong, troll.

Greg Webb December 7, 2011 at 11:04 pm

Let the troll alone. It’s just the Luzha.

Seth December 7, 2011 at 12:02 pm

A problem I have with the ‘apocalypse’ argument is that I’m not exactly sure of the specific mechanism that makes it worse to concentrate the losses on the folks who took the risk than to spread them out to those who didn’t.

The losses will be realized some how. Is there a loss multiplier when the losses are concentrated that make them worse than when they are distributed? Just not sure how that works on the micro level and I have yet to hear it explained in anything but broad strokes.

Jeff Neal December 7, 2011 at 9:23 pm

EXACTLY right and well said. Thank you.

nailheadtom December 7, 2011 at 1:01 pm

The impression that the masters of the universe give is that allowing the failure of the largest banks and corporations will eliminate the credit that businesses need to operate, leading to bankruptcies, closures, devastating unemployment, rampant disease and world-wide starvation. We don’t know for sure that such a scenario is inevitable but can we take the chance? Allowing General Motors to fail could have resulted in long lines of the unemployed and their families trudging down I-90, scavenging the fields for corn and thus putting a dent in the raw materials needed for the ethanol mandated for motor fuel. It’s just too big a gamble.

Jeff Neal December 7, 2011 at 9:27 pm

Excuse me? Failure of GM would lead to such only if the world stopped needing cars, or transmissions or windshields or tires or . . . and didn’t need whatever those people would have been making instead of those tires, etc that the market didn’t want anyway.

The GM model was broken and should have failed. The production facilities of the parts of the cars the market needed/wanted to buy would have to be manned by someone – who better than some significant portion of thousands of people who had been doing it for the previous 10 or 15 years for GM, so they’d be spared the horrible fate you describe, yes?

Richard Stands December 8, 2011 at 12:16 am

GM did fail. They filed for bankruptcy on June 1, 2009, after their TARP bailout. And then they poofed out of existence, and all their suppliers went away, and the auto industry as a whole ceased to exist.

…right?

Mueller December 8, 2011 at 9:18 am

Allowing GM to file for reorganization would have led to the bondholders getting something. It would have meant the suppliers would get something. It would have cut out those divisions that were unprofitable. It would have required the unions to renegotiate their contracts. In other words GM would have risen or fallen all on private money.
Instead the taxpayers got the Volt.

Jeff Neal December 7, 2011 at 4:58 pm

Losing lots of money is painful, but it’s not deadly. I know from personal experience.

Propping up banks (and homeowners, and car manufacturers) is a horrible misuse of capital, skews future decisions, encourages bad business decisions (moral hazard ring any bells). Let failure happen. It’s part of capitalism. Preventing it is the opposite of capitalism.

This policy of putting foam on the runway (a phrase some of the dummies love to use – makes ‘em sound smart) is like giving a cancer patient a sedative and a pain killer. Doesn’t do a damn thing to cure the disease, but it feels good for a little while. Yes, operating on the tumor will hurt, but it won’t kill him – letting him die of cancer isn’t while making him feel better isn’t saving or curing the patient, and the tumor gets bigger by the day and will consume him. (Is the metaphor beaten to death yet?)

Mueller December 8, 2011 at 9:13 am

What’s Worse Than An Apocalypse?

An Apocalypse and then a prostate exam?

Economics501 December 8, 2011 at 1:25 pm

Robert Weiman latest book ‘Aftershok’ 2nd version is exhaustive economic analysis of where we are right now and where we may he headed. This s very relevant to topic here. Great book review in http://economics501.wordpress.com/2011/11/25/aftershock-economy-book-review/

Random Blowhard December 8, 2011 at 9:25 pm

Salt Water Economist – We tried austerity and liquidation from 1929 to 1933. It doesn’t work.

Actually it worked great. The goal was to nuke away all the bad debt and allow the “real value” of things to be determined.

The problem is the real value of things such as a person’s job or their 401k has been so inflated via financialisation that a “real world” adjustment would plunge the vast majority of us into poverty and destitution.

My question is – How much longer can we kick the can via bailouts, extend pretend and printing before hyperinflationary collapse triggers disaster anyway? That which CANNOT continue WILL not, only the timing is in doubt.

The debt CANNOT be paid, it really is that simple.

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