Socialism for the rich - continued

NYT:

Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman Ben S. Bernanke convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan.

They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers generally expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of financial insurance to investors who bought complex debt securities. That effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, which in turn would have reduced their own capital and the value of their own debt.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”

Okay, now for my "yes but".

I agree. AIG, like Fannie and Freddie, needed to be bailed out. By taking on the financial problems of one organisation, the Federal Reserve can then dilute its negative effects upon the economy. Rather than AIG getting a bullet in the heart, the Fed catches it, breaks it up into little pieces, and then hurls each little piece at taxpayers and businesses - hurting them but not killing them. In a massive financial emergency, such an action will help mitigate the negative effects of one company's distress. It is, in other words, a classic socialist action - the many paying for the pain of one.

Nevertheless, the Fed is playing with fire here. America's entire financial system is based upon free market ideas that sets aside direct government interference in the marketplace and desires less regulation imposed upon them by this government. With the American financial industry partly collapsing, it could be argued that if the government should turn up to mitigate market failure then the government should also be there when things are going well, regulating the industry and profiting from it through tax revenue.

At some point, the money paid by the Fed and the US Treasury for Bear Stearns, Fannie Mae & Freddie Mac and AIG has to be accounted for. Money has to be found to rebalance government coffers.

Of course, both the Fed and the US government share in the blame for the current financial mess. Both Congress and the White House have, since 2001, decided to be fiscally irresponsible and cut taxes during an economic expansion. Moreover, the Fed kept interest rates ridiculously low under Greenspan from 2003-2005 and has created negative real interest rates during that period and also more recently under Bernanke. Negative real interest rates were one of the reasons why an investment bubble formed, and one of the reasons why it has popped so badly.

But let's get real. Were any Wall Street bigwigs warning the Bush government to stop cutting taxes or telling the Fed to raise interest rates? No. It was pressure from the financial markets that dictated America's expansionary fiscal and monetary policy in recent years. While we can certainly find time to blame Bush, Bernanke and Greenspan for kowtowing to the market, we should also find time to blame the financial market itself for promoting such ruinous policies.

Which means that, of course, the financial markets are simply reaping what they sowed. They profited from a bubble, now they are paying for it popping.

Except that they're not - at least not at the moment.

Where is the government going to get the money to pay for their "socialism for the rich"? Will they raise business taxes? Will they increase the top tax rate? It is the rich who created this financial black hole, so why not make them pay for it?

Of course the government could simply increase income taxes on everyone, which will then burden everyone with the problems created by a few. The government could also decide to cut defense expenditure or health expenditure to cope with the increase in debt. They could also just print money if they want to and create a Weimar hyperinflationary event. Or they could just ignore the debt, keep borrowing whatever they need, and then watch the US Dollar eventually crash.

My solution?

• Cut military spending
• Raise taxes on the rich
• Run a fiscal surplus to pay back public debt
• Use monetary policy to keep inflation low
• Create and enforce stricter financial regulation so this doesn't happen again.
• And, of course, fire Bernanke.