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This Bailout is Great! A Response.

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January 31, 2009 – Comments (24)

I just finished reading Richard Gibbons defense of the bailout. I think he meant the $700 billion original bank bailout but it's hard to tell. Regardless of whether it's Bailout #1, #2, #3, or however many we end up having (I think it will take 15 before we see rioting), I am happy to refute Richard's position on the following 7 points.

1. Richard does not comprehend the cause of bank failures.

2. Richard does not understand capitalism.

3. Richard does not understand The New Deal.

4. Richard does not know the fallacies of Keynesian economics.

5. Richard does not know what an honest lender is.

6. Richard does not understand how The Federal Reserve works.

7. Richard can not imagine an actual free market economy.

1. Richard does not comprehend the cause of bank failures.

Why does a bank fail? There are many reasons. Banks operate with a fractional reserve, meaning one deposit can be lent to other borrowers several times over. If confidence in the bank erodes, depositors may demand all their money once, causing the bank to collapse. Banks may misprice risk. If a bank consistently lends money at an interest rate lower than the market rate for a particular loan would indicate, the losses will eventual force it into bankruptcy. 

There is, of course, no reason that a bank can't hold 100% capital reserves. Except that by doing so, you would limit the amount of credit available. At least, the amount of credit available through banks. In the modern economy, credit is available in many ways but few realize how diverse it is. In fact, the amount of credit available remained at all time highs during The Credit Crunch. So much for a crisis.

In fact, the only way to keep a bank honest under a fractional reserve banking system is to allow it to go bankrupt. Bankrupt banks serve as nice reminders to other banks to properly calculate risk.

2. Richard does not understand capitalism.

"Bank executives don't care about systemic risks -- often they barely care about their own shareholders."

Since when are bank executives Capitalists? The role of the entrepreneur is to allocate capital. The role of the shareholder is to provide capital to the entrepreneur in exchange for a dividend or expected rise in company value. A bank executive that answers to the shareholder is not a Capitalist. He/she is a bureaucrat. We are now talking about the fundamental difference between Capitalism and Corporatism. In Capitalism, the interests of the business manager with the greatest stake in the operation often diverges from the interests of the shareholders. In an efficient company, those business managers make the decisions most suitable to the future of the company regardless of the interests of the share holders, because ultimately the entrepreneur must answer to the consumer not the shareholder. Rarely do we see a bank executive whose personal fortune rests on the performance of the bank itself. In those banks where this is the case, the overwhelming majority of them opposed the bailout! Go figure.

3. Richard does not understand The New Deal. 

At least in this regard, Richard is not alone. In fact, Nobel Prize winning charlatan.. er, Economist Paul Krugman has stated on several occasions that Hoover did nothing and only FDR saved us. Hooey! There is a mountain of evidence that FDR only continued Hoover's pre-New Deal. There is a mountain of evidence that FDR prolonged the depression. There is a mountain of evidence that not only did FDR worsen America economically, but he also greatly reduced American liberty, crushed the ability of the owners of wealth to protect themselves, engaged in Fascism, and provoked Japan in order to mobilize the citizenry.

If any one of these assertions can be proven true, then FDR should be regarded as a horrible President. If all of them are true, he should have been put in jail.

4. Richard does not know the fallacies of Keynesian economics.

"Out of false theories of employment, money, and interest, Keynes distilled a fantastically wrong theory of capitalism and of a socialist paradise erected out of paper money. Moreover, Keynes offered no theory of stagnation at all. He merely gave a perfectly normal phenomenon, such as falling prices a bad name, so as to find another excuse for his own inflationary schemes." - Hans-Hermann Hoppe, Professor of Economics at UNLV

Since Hoppe has recently put together a tremendous work on this, not to mention Henry Hazlitt's rebuttal of Keynes, Nobel Prize winner Hayek's work on The Business Cycle, and countless others, I am just going to link them and move on. Keynes' work has been so thoroughly discredited it must be put into some sort of context. Since his views generally call for government intervention, is it any surprise that the government would continually promote Keynesian thinkers?

5. Richard does not know what an honest lender is.

 I am an honest lender. I make Person-To-Person loans through a couple of different websites. I am limited by the amount of capital that I have available. In order to stay in business I must properly caclulate risk. If I fail to assess risk in the proper manner, I will go out of business because I do not have a lender of last resort. That's what keeps me honest. If I had an unlimited trough of money at my disposal (The Federal Reserve) it would be impossible for me to properly assess my risk. You can't calculate something that is infinite, e.g. The Federal Reserve's ability to create money. There are honest banks out there. Those banks aren't on The Fed's handout list. Those banks suffer when the dishonest banks get bailouts. That's the world that Richard wants to live in. You can't have it. I moved out of the country.

6. Richard does not understand how The Federal Reserve works.

Much ink has been spilled on this subject as well. The battle to control central banking has waged throughout American history. At first, those in favor of a central bank, like Alexander Hamilton, were honest about it. They wanted more power for the federal government and understood how such a bank could create it. They were called federalists. Andrew Jackson smashed one of our earliest central banks during his presidency, making him one of our greatest. Woodrow Wilson, bought and sold by the bankers, brought it back. People point to the bank panics of the late 1800's and early 1900's, but there is a great deal of evidence that J.P. Morgan and fellow financiers helped create those panics in order to secure a favorable atmosphere for the central bank discussion. In other words, our ancestors were duped.

7. Richard can not imagine an actual free market economy.

A collapse of the megabanks scares Richard (and most people.) They can not imagine a world without Citigroup or AIG or maybe even GM. It's scary. Others businesses would fail. People would be put out of work. There would be chaos and maybe even, revolution. Why doesn't this scare me? Because I'd still have my brain, and you would too. As I have said before, mining for gold starts in your own brain. Those of us that have filled it with knowledge will prosper no matter what supposed calamity arises.  Having an imagination makes humans special. Nearly everything in our world was created thanks to the imagination of an individual. 

I also never fell for the easy credit ideas of the leveraged society. I bought only what I could afford. I lent only what I could afford. If I needed credit for an emergency situation, I paid it off quickly. I have never held a loan to maturation. Not a home loan. Not a car loan. Not a school loan. I pay for everything in cash these days. It's the reward for my success and my knowledge. It is people like me that would thrive should the big banks disappear. There are a lot of people like me. Do you think we deserve it, or would you rather have megabank bureaucrats in charge?

David in Qatar

24 Comments – Post Your Own

#1) On January 31, 2009 at 11:52 AM, DaretothREdux (42.13) wrote:

David you are brilliant! I would rec this 100 times if i could. You are exactly right when you say that the people who did everything right are now being punished and those that did everything wrong are being rewarded...just imagine what will come of that society after everyone figures out that being stupid will get them a reward!

Hopefully...we will find the right path before that day comes.

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#2) On January 31, 2009 at 2:07 PM, drummnutt (< 20) wrote:

Do you realise that the reason the 1930's was so bad is because US banks failed en-mass and that people therfore withdrew any money they could and stored it in mattresses. Then the US government introduced protectionist policies which made things worse. Thankfully governments around the world have learnt from these blunders. Always remember, there are those that CANNOT work and therfore not pay for your health and education.

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#3) On January 31, 2009 at 2:16 PM, TMFDiogenes (75.87) wrote:

David, interesting stuff. I'm wondering, since I dislike the bailout as much as anyone else but regard it as necessary and have yet to hear anyone present a viable alternative, do you have an alternative that a) wouldn't run out the $85 billion in FDIC reserves, and b) not allow the financial system to collapse?

Ilan (Rich's editor)

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#4) On January 31, 2009 at 4:20 PM, whereaminow (23.21) wrote:

TMFDiogenes,

The answer in summary (I apologize for the brevity but it's after midnight in Qatar. I will go in detail tomorrow if you request):

1) Educate the public about the FDIC. If the public came to understand how FDIC worked, they would not support it.

2) Return to a true gold standard. Audit The Federal Reserve and make the dollar tied to gold, thus temporarily preventing bankers and politicians from destroying the currency, engaging in Socialism, and enriching their friends at the expense of honest men and women.

3) Eventually move from the gold standard to a free market money supply. More on this can be discussed at length if you would like. Gold Standards only work until politicians realize they have a monopoly on legislation, at which point they legislate themselves off the Gold Standard. They have a 100% track record of doing this.

4) Abolish The Federal Reserve.

David in Qatar

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#5) On January 31, 2009 at 6:49 PM, UltraContrarian (31.36) wrote:

You did not answer Diogenes' question, since those 4 steps would in fact accelerate the collapse of the financial system.

Returning the country to the gold standard would cause immediate money supply contraction, massive misinvestment and eventual default on our debts.

The gold standard was one of the major factors behind making the Great Depression international.  The countries that were on silver or that had already floated their currency fared a lot better than the countries that tried to stick with gold.

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#6) On January 31, 2009 at 6:55 PM, ajm101 (31.81) wrote:

I had no idea the John Birch society was opening a Middle East chapter.  

Point #7 made me laugh out loud.  Maybe it's just that the "megabank bureaucrats" have brainwashed me.

 

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#7) On January 31, 2009 at 7:21 PM, whereaminow (23.21) wrote:

ajm101,

Mockery trumps critical thought everytime I suppose, particularly when you are incapable of building an argument. In that case, Point #7 should make you laugh, since you it speaks of people who have filled their heads with knowledge.

UltraContrarian,

Using Keynesian economics you can not save the country from financial collapse, you can only continue to prop up failing institutions at the expense of solvent ones by increasing the money. Since debasing the currency caused this mess and the Great Depression (see Rothbard's America's Great Depression and Hayek's Road To Serfdom), it is absurd to think debasing it more will correct it.

The Gold Standard was not a factor behind the Great Depression. The Federal Reserve was. I have produced the work of a dozen economists including Nobel Prize winners that support this theory. Please produce one that believes the Gold Standard caused the Great Depression.

David in Qatar

 

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#8) On January 31, 2009 at 7:27 PM, UltraContrarian (31.36) wrote:

The link above that claims FDR prolonged the Depression by 7 years is still the stupidest scholarly article I have ever heard of. 

Not because of the conclusion - almost everyone agrees there were plenty of things FDR did wrong, which in hindsight could be improved on. But the analysis is atrocious.  The bubble year of 1929 is a ridiculous baseline for prices and wages, and furthermore deflation had been occuring for 2 years under Hoover before FDR even took office.

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#9) On January 31, 2009 at 7:33 PM, mts883 (< 20) wrote:

good lord, it still surprises me that, even after all that has happened, there are still those who believe in the nonsense put forth by the likes of Hyek and Mises.

If you want to get some perspective on this financial crisis i encourage you to read up on the one that befell sweden in the early 1990's. They provided capital to the banks to keep them from collapsing, and injected fiscal stimulus into the economy. as it turns out they actually wound up making  their money back.   

http://www.riksbank.se/upload/3861/970829e.pdf

Im not suggesting that the current crisis is exactly the same as this one, obviously the magnitude differs greatly, but i think some of the insights are useful. KEYNES FOREVER!!!

-Michael (ex-libertarian turned Keynesian) 

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#10) On January 31, 2009 at 7:40 PM, ajm101 (31.81) wrote:

I suppose all those idiots killed in Rwanda, Stalin's Soviet Union, the Khmer Rouge, etc... just lacked the necessary critical thinking skills and entrepreneurial spirit to turn their lemons into lemonade?  I have no need to 'build an argument' because point #7 is ridiculous on its face.  It's arrogance bordering on delusion.

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#11) On January 31, 2009 at 8:04 PM, ajm101 (31.81) wrote:

You know, I was out of line there.  I still strongly disagree with you, though.

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#12) On January 31, 2009 at 8:18 PM, streetflame (29.99) wrote:

"The Gold Standard was not a factor behind the Great Depression. The Federal Reserve was. I have produced the work of a dozen economists including Nobel Prize winners that support this theory. Please produce one that believes the Gold Standard caused the Great Depression."

The majority of economists agree that the Federal Reserve's lending policies and the gold standard were both primary factors behind the Depression.  It's not my fault if you only read Austrians.

If you really have no idea where to start, how about Ben Bernanke?

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#13) On January 31, 2009 at 10:05 PM, intpj (< 20) wrote:

I am impressed by the breadth and depth of your knowledge about the history and the meaning (and interconnection) of the historical events, as well as sound economic & monetary theory.

 First deflation than inflation will separate most fools from their money.

 Good luck to you.

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#14) On February 01, 2009 at 10:05 AM, thomgonz (< 20) wrote:

Very well written post. I wish I had half the time you do to sit around reading in Qatar...Oh wait I do. For the Keynesians out there, my question is simple, at what point do you stop meddling in everything? Handing a government control of your money is asking for trouble. When a few well placed bribes can make your company instead of offering a quality product. I'm sure all of you socialist economists hate the book, but look exactly at the situation put forth in Atlas Shrugged. When a few corrupt people get to choose who gets help while others don't you make and break companies as well as infringe on peoples rights of property. Oh, car maker A has 3 lobbyists while company B doesn't. Company A gets a 15 billion dollar bailout which they use to either buy company B or drive them out of business. Look at the nonsense of the auto bailout. Ford, GM and Chrysler get more money then most of us will produce in our lives while startup companies that might actually make a new product get shafted. You want to fix the economy. It's simple. Stop supporting every country in the world with our firebrand "democracy" like it's a damn crusade. If countries like Qatar, Germany, Japan and the other 150+ that have America there to do it for them would pay for their own national defense that wouldn't leave them the extra money to subsidize all their industry and sell it cheaper than American goods. Then guess what we would start producing again (as soon as we fix our stupid tax structure) and there you go fixed economy. On the other hand, when we no longer have an empire spanned across the globe, no countries are going to buy up our bad debt at gun point like they are now. And anybody who tries to use the argument that America is in foreign countries to defend America, you are an idiot and a tool. I know for a fact America would be safer if we stopped our current foreign policy and moved all our troops onto American soil and our ships and planes within 200-500 miles of our border. On top of that, half the world would almost over night stop hating us. Gonzo

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#15) On February 01, 2009 at 12:51 PM, streetflame (29.99) wrote:

I have always found it strange that the people demanding the government leave the economy alone are some of the same ones demanding price fixing of gold.

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#16) On February 01, 2009 at 9:36 PM, jester112358 (28.79) wrote:

Brilliant defense of the central role of the individual, not the collective, in all the benefits we enjoy in modern life (point #7).  As a research scientist I can verfy that collective actions rarely result in anything of true value in science.  The skills and intelligence of an individual can never be taken away, even by an all powerful government or corporation.  Such an individual, like John Galt, will simply withdraw his skills from the parasites in any society-and they will whine like crazy since they have no skills!  This is the essence of liberatarian philosophy and the Austrian school of economics.  As Ayn Rand, wrote, "philosphy, who needs it".  Instead, we liberatians live by the modern motto "just do it" and no whining when things get tough.  Work hard, save, invest and produce more than you consume.  Just the opposite of whining "progressives" who like to invoke "fairness" as the central point of an argument when reason and fact seem to contradict their opinions.

 And for those interventionist Keynesians who want more nanny government control, the concentration of power is always a mistake.  Even a government is not too big to fail as Rome discovered.

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#17) On February 01, 2009 at 10:38 PM, MariaFolsom (< 20) wrote:

The 'morality' issue has barely been mentioned - just one post includes it, I believe. Whose money are we talking about, anyway? If I earned it, why don't I have the right to decide where it goes? Why does Big Government get to decide? Even if such bailouts would work (and they wouldn't, and I agree with most of these posts) it would be wrong because it's MY MONEY.

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#18) On February 02, 2009 at 9:32 AM, whereaminow (23.21) wrote:

MariaFolsom,

It's important to understand that the financial policy of the welfare state is to make it impossible for the owners of wealth to protect themselves.

Let me give you an example. The government has decided that they can't place further taxes on the people lest they protest and remove them from office. Instead they turn to The Federal Reserve to increase the money supply, thereby creating an Inflation Tax.

The alternative, for the owner of wealth is to invest in real estate and metals. The welfare state attacks these through Estate Taxes and making certain metals illegal to hold.

In other words, Marxism has been alive and well in America for 100 years, working side-by-side with free market Capitalism, and slowly but surely eroding the foundations of liberty.

David in Qatar

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#19) On February 02, 2009 at 10:27 AM, MariaFolsom (< 20) wrote:

David in Qatar,

You are right. Excuse me for slipping into moralism and ethics! As you say, these other 'stealth taxes' as they are called have been with us for decades. Nonetheless, if We the People keep reminding each other about the morality-side of this issue, perhaps these stealth taxes will be a little more distasteful; perhaps we can arouse some decent shame and confusion among the populace as to the propriety of such government theft. Then again, perhaps not.

Thank you for your post.

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#20) On February 06, 2009 at 3:55 PM, nzsvz9 (< 20) wrote:

Dear whereaminow aka David in Qatar,

Thank you for your rebuttal. My first thought when reading the original MF article was that the writer made the bold assumption that the banks were free market entities; they are not. Just as most people think that the Federal Reserve is part of the government; which it is not.

The founding fathers of our country warned us that to lose control of the currency was to lose control of the government, and it seems their foresight was providential. We have lost control of our government, and our money - both. When the American revolution began, over unfair taxation I might add, there was a mere 1% of the people who organized and started this grand experiment, pledging their lives, property and sacred honour.

Where are the 1% now?

Known by many as nzsvz9

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#21) On February 06, 2009 at 5:29 PM, BoctorBill (< 20) wrote:

"Since debasing the currency caused this mess" ...

Wow, you really asserted this? You're labeling the financial industry's mishandling of funds as a currency debasement problem?

The big investment houses built a giant house of cards based on idiotic risk models, bad lending practices and something that could never, never work in the long run: credit default swaps. Eventually, individual loans often supported hundreds of these. When those loans went down, the payment of credit default swaps swamped the industry, and capsized it.

Seriously. Currency debasement. Oh, to laugh.

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#22) On February 06, 2009 at 6:01 PM, LeonardChallenge (< 20) wrote:

Dear David,

Your article is excellent, well written and well thought out.  It is obvious that you are an autrian economist and follow on the tradition of the austrian school.

 Please allow me to make a suggestion.  I find Hayek's Use of Knowledge in Society to be of relevance here.  Of course, it does not explain how banks work, how the fed. system work etc; knowledge of which is central in assessing the reasons for the systemic failures we have seen.

But Hayek shows without a question of doubt why no centrally planned anything can ever succeed, and central planning is in the end the ultimate goal of Kenesians and their followers.

I encourage you to write on the topic again linking your ideas to Hayek, Friedman, Sowell's and others.

Best Regards,

leonard

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#23) On February 06, 2009 at 6:09 PM, MONEY1977 (< 20) wrote:

Interesting clip about Federal Reserve and the Banking Institution...

http://www.youtube.com/watch?v=_dmPchuXIXQ

Very Conspiracy driven... but who knows??
I put nothing past the govt..


Whole Movie...

http://www.youtube.com/watch?v=0kHhc67GopM

I dont believe half the stuff in this film but I thought the banking thing seemed interesting considering all thats happened as of late..

Check it out..
Id like to hear others opinions.

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#24) On February 06, 2009 at 10:36 PM, estate1997 (84.20) wrote:

If the politicians are motivated by money, meet me at the bank Monday morning to withdrawl all the funds, They will listen when there is no money.

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