Let Them Go Bankrupt; Save a Trillion Dollars

Published September 24, 2008

Congress, the Treasury, the Securities and Exchange Commission, and the Federal Reserve are hell-bent to bail out the housing and financial industries and then regulate them into rigor mortis. All this with no judicial review and a bill for taxpayers on the order of $700 billion to $1 trillion, not including higher inflation. It makes the funding for the Iraq war look like chump change.

Is there an alternative? The answer in one word is yes.

The troubled financial institutions should be allowed to go bankrupt. This does not mean an end to all operations. Instead it is a discipline to separate the viable parts of the institutions from those that are not viable. Those in charge are the creditors. They are the ones who know best the future business prospects and have their own stake in the operations. This is different from some anonymous, 20-something, bureaucratic bank examiner who knows only how to liquidate, if that much.

Moreover, there is an established body of law and precedent in the bankruptcy courts. There is no need for a czar. Anyway, Mr. Putin is busy with his own economic disaster. There is likewise no reason for forced mergers. This has been tried with the railroads and failed. In 1968 the New York Central was acquired by the Pennsylvania Railroad with the approval of the Interstate Commerce Commission. The ICC also insisted that the bankrupt New Haven and Hartford Railroad be folded into the new entity.

This was done in 1969. A holding company was established to broaden investment in real estate and other lines of business, but the measures were not enough to stave off bankruptcy, which happened in June 1970. The problem was not resolved until 1980, with the passage of the Staggers Act, which effectively deregulated the railroad business.

In today’s situation, the damage to the market in credit default swaps and other over-the-counter markets has already been done. It will take a long time before these contracts become exchange-traded with a clearing operation, which in my opinion is the only viable solution. With the dead hand of government on these markets, recovery will take even longer.

If you liked how the Federal Reserve aggravated and prolonged the Great Depression in the 1930s, you are going to love the government “solution” to the current financial crisis.

Jim Johnston ([email protected]) is a policy advisor to The Heartland Institute. His views are his own and not necessarily those of The Heartland Institute.