Unforeseen Contingencies

That's the United Socialist State Republic of America in Nouriel Roubini's words.

With the AIG nationalization, the United States government has become the world's largest insurer. Now it intends to become the world's largest holder of mortgages, in effect the biggest owner of America's housing stock. The mainstream media is suggesting this will cost $500 - $800 billion. That's probably the lower limit.

There's much that might be said about these disastrous developments, but here are a few points I think most important.

1. The misinvestments have already been made and resulting losses cannot be averted, the milk is already spilled. The only things that can be done are (i) to shift the "costs" (damages) and (ii) to try to avert further damage.

2. The federal move is supposed to address (ii). I think it mostly does (i). The taxpayers become the owners of the downside risks. The argument that Main Street U.S.A. is intimately tied to Wall Street NY is true, but this bailout transfers downside risk and losses directly to people who never meant to take them on, and protects people who did. (Incidentally, taking on risk and failing isn't a crime, nor immoral, although it is being portrayed this way lately.)

3. The distinction between private property and public (government) property is vanishing. We're socializing losses, so why not profits? And since capital markets failed, shouldn't government direct capital flows? Proposals for central planning in various guises are in the works, and this ill-begotten plan will lead the way.

We already have a method for dealing with these problems: it's called bankruptcy. Let firms that fail, fail. This isn't the USSR, let's take our market discipline. If it really is the case that unacceptable harm is done to some, e.g. homeowners, go ahead and spread that damage among the taxpayers. But don't make the feds the owners of the U.S. economy. Congress must block this scheme to shift downside risk onto the taxpayer, and put tremendous power into the hands of the executive branch and Federal Reserve. I know, slim chance, but it has to be done.