For those of you who haven’t read it in the New York Times, it would seem that Peter Bernstein has added his voice to Ben Stein in saying that he’s not really sure what is to be done. Bernstein is a writer I respect, for he is one of the few people who talk about the economy today who has knowledge of the history that has come before it. I find that most economists or economic pundits seem to have no knowledge of history whatsoever, and thus have no means with which to test their theoretical knowledge (much of which came from Keynes) against actual historical events. Given that you can easily find many historical refutations of many aspects of macroeconomic theory, I can’t say it’s surprising that economics and history are treated as two separate disciplines with no actual overlap by most people.
Bernstein is an exception to all this. His books, such as Against the Gods are almost nothing but history. However, despite his historical frame of reference, Bernstein still marvels as the modern wonders of macroeconomic theory as though it were the culmination of all the experience gained from all prior events that he talks about in his books. Like virtually all people today, we have a bias towards are modern ways; surely they must be superior to the archaic way that people used to do things. This bias seems to have convinced Bernstein that the bailout plan that Congress is putting together is the correct thing to do. As far as he is concerned, it must happen, else we will revisit the times of the Great Depression when the streets of Manhattan were “filled with unshaven men in threadbare clothes, their coat collars turned up against the cold, their shoes stuffed with newspaper to plug holes in the soles.”
It seems clear to me that despite Bernstein’s historical knoweldge, he has not read any of the great works of the Economic Historian Murray Rothbard. Anyone reading America’s Great Depression would know that is was precisely these types of bailouts that President Herbert Hoover tried at the very outset. Dr. Rothbard clearly shows how the price support mechanisms that President Hoover put into place to maintain the prices of everything from wages to wheat all failed miserably and merely exacerbated the economic downturn and that the “banking holidays”, gold confiscation, and deficit spending of FDR also simply made things worse. After all was said and done in regards to The Great Depression, all that had been accomplished was to for the government to claim responsibility for the economy and to adopt previously unheard of authority to achieve a promised ends that it never could. Thus what we are seeing today is more of the same of what we have already seen before. It didn’t work then, and it won’t work now.
But Bernstein seems oblivious to all of this, which is tragic given his historical knowledge. But he does analyze where today’s situation could lead if it should succeed- to an even more pronounced level of risk in the economy. You see when you provide insurance for something, you often provide an incentive to do the very thing you are insuring against. It’s called “moral hazard” in the insurance industry. For example, if you take out a insurance policy safeguarding your house against fire, you now have a motive to burn your house down and claim the cash reward.
The same problem is at work in today’s markets. By way of this bailout, the government is adopting what Bernstein terms a policy of “Thou Shall Not Fail” regarding the banking industry. So, by the logic of moral hazard, the banking industry now hse incentive to take even bigger risks because the government will always be there to bail them out should they go wrong. Much like the “Greenspan Put”, today’s bailouts done for market stability will lead to an ever increasing amount of risk and instability in the future. Anyone can see that this process can only continue until, inevitably, the entire system fails. Bernstein himself declares the absolute necessity of the bailout, but sees the moral hazard implications. Thus, he ends his NY Times piece by saying “As we move into the future, and as the crisis finally passes into history, how will we deal with this earth-shaking blow to the most basic principle of our economic system? I do not know how to answer that question. But we need to ask it.”
You can ask all you want Bernstein, it won’t change a thing. Markets will take on increasing risk until they exceed the guardian’s ability to stabilize it. When that point it reached, the collapse takes down the whole system with it. This points to why the bailout is merely an exercise in folly. History tells us it will do nothing but prolong the crisis and, should it actually succeed, it will only manage to insure that the next crisis is even more pronounced.