The insurance bailout

The whole debacle with the US housing market, and, in particular, the bailout of Freddie and Fannie, raises some very important questions as to what the role of government should be in supporting the economy. Proponents of the bailout argue that Freddie and Fannie are so central to the operation of the US mortgage market that their collapse would spell an economic catastrophe. However, my fear is that the alternative – a bailout – while attractive in the short term, could be far more catastrophic in the long term. Specifically, a bailout skews the risk analysis by companies, since they come to assume that if they run into trouble the government will bail them out. This in turn encourages irresponsible risk taking behaviour, which, in the long term, will lead to the same problem of over exposure to risk arising again and again. So as a rule of thumb I tend to oppose bailouts, no matter how dire the situation may appear in the short term. One of the most pivotal aspects of a market system is that market participants need to take responsibility for the risks they take. This in turn encourages responsible risk taking. Bailouts (or any other form of government backing) completely destroy this important feedback mechanism.

5 thoughts on “The insurance bailout”

  1. Once again America proving they are the least “free market” in the world…! Whilst they go gun toating around the world bringing democracy and free markets so they can keep local populations subduded and resources utilised to support their own economic purposes.

  2. I’m inclined to agree with you, Pete. The Bush administration should feel shivers of hypocrisy running down its spine…but this bailout just goes to show that the current admin. is in fact spineless and truly a tool of business. I think we’ve all just learned a big lesson. I imagine you’ll call it a lesson in reckless risk taking. I call it a lesson in regulating markets.

  3. “shiver’s of hipocrisy”… i like that, very evocative.

    Pete, it’s the ‘no matter how dire” part which i have a problem with. It seems fairly uncontroversial to say this has the potential to be the worst downturn since the Great Depressions. If so then that puts the onus on you to explain what you would have done in the 1930’s and/or how it could have been more (or even as) effective as the socialistic solutions applied back then.

    I think we come back to the usual dilemma which assails debates about under/over regulation of markets. The current situation is pretty crappy, and the credit crunch is but the latest indicator. But since we have this free market/centrally regulated/semi-protectionist/crony capitalist hybrid, each side can blame the other for the current problem. Therefore Peter can argue that the US economy needs less intervention and Emily can argue it needs more adn/orsmarter regulation. And neither are demonstrably wrong, as far as it goes.

    I would far prefer either of those alternatives to be given a shot than what Bush etc are giving us now. ie: more of the muddled up same.

    nb: what i just wrote really applie sonly to the post war global economy. I think that the state market realtionship up until then was a generally healthy one and maybe something to look towards as far as smarter and less intrusive regulation

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