It will, for example, substantially reduce the profitability of investment houses and, therefore, reduce their scale. But that’s the price you pay for access to a publicly financed safety net.
That is why some economists cringe when Wall Street firms are bailed out. Beyond the obvious equity issues about risking taxpayer money to help rich guys, there is the problem of efficiency. If you start bailing the firms out when they lose, you have to regulate the gambles they take. You can no longer count on the creditors to limit the firms' leverage, as the creditors are counting on Uncle Sam if things go wrong. But the more regulated these firms are, the lower their productivity will be.
The bottom line: The Bear Stearns bailout may have saved the economy from an episode of financial contagion in the short run, but in the long run it will likely leave us with a more regulated and less vibrant financial system.
I disagree. Lack of effective regulation opened the door for this crisis, and if the Fed had not intervened, there was a strong possibility that the financial system would have had a severe meltdown. Maybe not, but the chance was there and it wasn't a chance most people were willing to take.
Suppose we do nothing and there was a meltdown as feared. One need only look back at the aftermath of the Great Depression to see what happens to regulation after such an event - there was a strong regulatory response. Given the choice between a bailout and the level of regulation that comes along with it, and a crash and the much larger amount of regulation that would follow, it's hard to see why choosing the path that, in a probabilistic sense, gives a smaller likelihood of a major crash and a smaller regulatory response would be objectionable. Financial markets screwed up and they know it - that was quite evident this week at the Milken Institute Global Conference - and they accept that more regulation is needed. The choice isn't between no regulation and some regulation, there will be a regulatory response and the question is how large and effective it will be.
The chance that there would be a financial meltdown had the Fed remained passive instead of intervening is why the statement below from Hillary doesn't make a lot of sense. The equivalence she draws between the financial market bailout and lifting the gas tax is false. The Fed intervened to prevent a financial meltdown, and that helped all of us. There were costs, but the benefits - avoiding a large crash - were far larger.
There is no such necessity for a gas tax, the system won't crash and burn if we do not lift gas taxes for the summer, and the calculation is different. With the financial bailout, we had little choice but to accept some costs in order to prevent far larger costs associated with a meltdown. But given that intervention was needed, the policy that was implemented did not have obvious problems, every economist on the planet did not jump up and say there's a better way to do this! Some did, but the objection was to intervening in financial markets at all. Most agreed this was the best way to proceed if they accepted that that intervention was needed, though there were a few voices advocating variations on the policy. With the gas tax, it is just the opposite - there are no economists I know of that support the policy, not one. Even if they support the idea behind it, giving relief to lower income households, they do not support this particular means of addressing the problem:
Clinton Pushes Back on Gas Tax ‘Pushback’, by Matt Phillips: Hillary Clinton’s sit-down with George Stephanopoulos on ABC’s “This Week,” quickly delved into her plan to suspend the federal gas tax during the peak summer driving season.
Stephanopoulos ... played a clip of Sen. Barack Obama criticizing the plan. Obama quoted New York Times columnist and Princeton economist Paul Krugman’s assessment that the idea is “pointless and disappointing,” and asked the New York senator to name “a credible economist who supports the suspension.”...
“Well I’ll tell you what, I’m not going to put my lot in with economists,” Clinton said, a response in line with some of the populist notes she’s been hitting in recent stump speeches on the gas tax.
She argued that the policy, if designed properly, could be effective. ... “But let’s step back for a minute George. You know, it’s really odd to me that arguing to give relief to the vast majority of Americans creates this incredible pushback,” she said, “When the federal government, through the Fed and the Treasury gave $30 billion in a bailout to Bear Stearns I didn’t hear anybody jump up and say, ‘That’s not going according to the market, that’s rewarding irresponsible behavior.’ We’ve got to get out of this mindset, where somehow, elite opinion is always on the side of doing things that really disadvantage the vast majority of Americans.”
First, people did complain about the bailout - see above for one, and many of the complaints hit directly on her main point, that "I didn’t hear anybody jump up and say, ‘That’s not going according to the market, that’s rewarding irresponsible behavior’." If she didn't hear that, or if none of her economic advisors did, then they aren't listening. That message was loud and clear.
The "if designed properly" part is strange too. Is she saying that as it stands, it's not a good idea, but she's pushing it anyway? Or is she saying that, as she has designed it, it is a good idea? Either way, it's bunk. She also says, "it’s really odd to me that arguing to give relief to the vast majority of Americans creates this incredible pushback." It's not giving relief that is causing the pushback, there are ways to give relief that don't give up on our environmental goals and have better efficiency properties, e.g. a lump-sum rebate to lower income households. The pushback is about the form of the policy, not the idea behind it.
I'll have to vote soon - Hillary or Obama - and mail in my ballot (we vote by mail here). I've had a bit of trouble deciding, but this will help.