The Inevitability of Bailouts

Via Pat Garofalo, I see that Rick Perry is preaching the dangerous gospel that we can solve all our financial regulation dilemmas with “a simple promise” of “no more bailouts, whether we’re talking about bailing out bankers in America or we’re talking about bankers in Europe.”

To an extent, bailouts are in the eye of the beholder. But some kind of intervention to prevent bank failures is inevitable in a modern economy. The important thing to realize is that it’s more than bankers who have something on the line. Firms accumulate money at different times from when they accumulate expenses. That means that to run a business, you need someplace to park your funds when you don’t need them or someplace to get extra funds when you do need them, or both. That place can be a formal, regulated bank or it can be a part of a “shadow banking system.” But either way, a place that’s in the business of paying you for the privilege of storing your funds there or charging you money to borrow funds is, in effect, a bank. And banks are subject to runs and panics. If people think that other people are going to pull their money out of the bank, then everyone does rush to pull their money out of the bank and the bank fails. If the bank fails, then a company that’s been storing money to make payroll at the end of the month is going to have no money and won’t be able to pay its workers. If the bank fails, then a company that needs to borrow some money to buy supplies in order to meet a big contract won’t be able to deliver on the contract. Both companies are going to have to shutter their doors, which is going to have additional negative consequences throughout the economy. No real world government is going to let this happen, nor should any real world government let this happen. The real issue isn’t “to bail out, or not to bail out” it’s what kind of supervisory regulation do you do in advance and how exactly do you deal with institutions that are in need of a bailout.