Someone this week asked me what I thought of policy-makers who ex ante profess a free-market ideology and acute sensitivity to the dangers of moral hazard from financial bailouts, but who toss that ideology overboard when faced with a financial crisis. The reference was to Treasury Secretary Henry Paulson’s lobbying this week in support of a rescue for Fannie Mae (FNM) and Freddie Mac (FRE), the two big home mortgage agencies, following on the rescue of Bear Stearns (BSC). My reply was: “They say there are no atheists in foxholes. Perhaps, then, there are also no libertarians in financial crises.”
There are more egregious cases than Hank Paulson of inconsistencies between ex ante promises by policy-makers not to bail out and ex post bailouts when disaster strikes. (Indeed, some amount of change in position may even be rational for an office-holder, though I would draw the line at false statements.) I reserve my disdain for those who go around lecturing others on the evils of bailouts, only to out-do the officials they criticized when their own turn in the hot-seat comes.
An example I have in mind concerns the members of the starting team in the Bush Administration who had lectured the Clinton Administration on the evils of its allegedly excessive bailouts of emerging markets in the 1990s, only to engage in worse when they themselves were faced with the Argentine crisis that began in 2001.
There was no particular reason to rescue the Kirchner government. Argentina in 2003 would have been the perfect place to refrain from rolling over an IMF program, thereby putting a limit on the moral hazard problem. The Clinton Treasury had done this with Russia in August 1998 despite high costs in terms of systemic contagion. Yet the Bush White House continued to push the IMF to bail out Argentina. Apparently the failing lay in simple inexperience and lack of awareness that any such choices are always difficult. (See pages 9-11 of my article on Managing Financial Crises, in the Cato Journal, Summer 2007.)
The Administration was very much following in the footsteps of the Reagan Administration, which talked tough at first when the international debt crisis hit in 1982 but which then participated in comprehensive IMF-led bailouts of Latin American debtors who had been pursuing far worse macroeconomic policies than the emerging market governments of the 1990s crises.
Incidentally, before writing this blog post, I checked into the World War II origins of the sentence “There are no atheists in foxholes.” I discovered to my surprise that this expression was intended, and is still considered, as a put-down of atheists, and that their lobby protests its use.
Of course the proposition is not literally true; indeed some soldiers lose their pre-existing belief in God when confronted with the horror of war. But let us stipulate that those who suddenly face death more often find religion than lose it. What strikes me as odd is that the expression is apparently normally interpreted as meaning that people who profess atheism don’t really mean it, and that their true colors come out under pressure. I had, apparently erroneously, thought rather the reverse. (Indeed, Richard Dawkins argues that vast numbers of people who would no more bet on the existence of God than on the existence of the Easter Bunny, nonetheless call themselves “agnostics” rather than atheists, to avoid rocking the boat.)
I had always taken the expression to mean that mankind’s hunger for religious beliefs comes from a desperate desire for divine intervention – or, failing that, comfort – when confronting death. Something more along the lines “There are no unsoiled underpants in foxholes.” I am in sympathy with the character in a novel who said “That maxim, ‘There are no atheists in foxholes,’ it’s not an argument against atheism — it’s an argument against foxholes.”
So what’s my point? Not to argue that governments should intervene always (nor that they should intervene never). The lesson for government officials is that wherever they choose to draw the bailout line – one hopes the line strikes an intelligent balance between the short-run advantages of ameliorating a serious financial crisis and the longer-run disadvantages of moral hazard — they should think through the system ahead of time. They should take the appropriate regulatory precautions during the boom times, which correspond to the bailouts that will inevitably come during the busts.
Long ago, the United States worked out the approximate right answer for banks: there will always be rescue of small depositors ex post when banks run into serious trouble, and so under our system, (i) deposit insurance provides formal guarantees and (ii) banks must pay the price ex ante through reserve requirements, capital requirements, and active regulatory oversight. What we now need to do is design the analogous sort of system for non-banks.
It should not come as a surprise to high officials that there are such things as financial crises anymore than it should come as a surprise to soldiers that there are such things as bombs. It shouldn’t be necessary to alter one’s fundamental beliefs when crisis strikes, in the absence of truly unforeseeable developments.