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Wall Street bailouts: Business as usual
Economics professor Allan Meltzer once said, "Capitalism without failure is like religion without sin."

President Obama's proposed reform of Wall Street calls for creating a list of large financial firms ("Tier 1 financial holding companies") that will be officially designated as "too big to fail." They will, in short, be guaranteed rescue by taxpayers if they get into financial difficulty. This will be disastrous because it will encourage further speculation and saddle taxpayers with the cost of cleaning up future trillion-dollar financial messes.

The simple fact is that this sort of big government coddling is what got us into this mess in the first place. Wall Street is not a bastion of free-market laissez faire capitalism. Consider this simple question: How many times have the big firms like Goldman Sachs, J.P. Morgan, etc. been bailed out in the past 15 years? The big firms on Wall Street have been rescued from their profligate investments half a dozen times since 1994. And that propelled us to near collapse in 2008.

For example, in 1995 the Clinton administration used taxpayer money to extend a $20 billion line of credit to rescue Goldman Sachs and others from speculative, high-risk Mexican government bonds they obtained through arbitrage. (Arbitrage means borrowing money to leverage your investment.) In the end, this bailout saw to it that the speculators not only got their money back they also received a healthy profit. ...

...One can argue that the fall 2008 crisis was so widespread and systemic that emergency action was necessary. But what President Obama is doing is creating a permanent arrangement between Washington and Wall Street. It is downright dangerous, the equivalent of bailing someone with a DUI charge out of jail, giving him the keys to the car, tossing a six-pack in the back seat, and telling him everything will be OK. Nothing good can come of it.

Bailing out speculators breeds more speculation. In the world of finance they call it "moral hazard," best defined perhaps by the British philosopher Herbert Spencer who once said, "The ultimate result of shielding men from the effects of folly is to fill the world with fools." Obama's proposed list of firms "too big to fail" will simply create more foolishness on Wall Street.

There is a huge distinction between being pro-business and pro-free market. The Obama administration is being pro-business because it is proposing to prop up individual firms at taxpayer expense. What it should be doing is being pro-free market, which means encouraging greater competition and letting fools fail.

Greed and speculation are a fact of life in human nature and on Wall Street. Can we really blame Wall Street speculation if we create a system where there is a limited downside? The best deterrent to speculation is to make sure that speculators lose their shirts when they bet wrong. ...