A quick note on corporate bankruptcy and bailouts

Bankruptcy is a necessary part of a free market. I certainly believe this to be so. Rick Newman, who writes the blog “Flow Chart” over at U.S. News, is putting forward the provocative idea that failure is exactly what we needed more of in 2008 and what we should want in 2009.

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Bankruptcy is a necessary part of a free market.  I certainly believe this to be so. Rick Newman, who writes the blog “Flow Chart” over at U.S. News, is putting forward the provocative idea that failure is exactly what we needed more of in 2008 and what we should want in 2009.

The idea is that  propping up bankrupt companies artificially constitutes a dead-weight loss to society and fosters a pernicious sense of invulnerability at many large companies. I tend to agree with these sentiments and this is one reason I do not support the bailouts of the automakers and why I did not support the way other bailouts like Citigroup, Fannie Mae, and Freddie Mac were handled.  However (and this a big however), systemic risk must always be kept in check.  Newman says as much.

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OK, so maybe all those bailouts have collectively served the national interest, by preventing a panic and dampening the effects of a nasty recession. But at some point—which we might have passed already—preventing failure does more harm than good. Here’s why we should be more tolerant of failure in 2009:

Bailouts perpetuate the problem instead of solving it. We’re probably about to learn that bailouts are an open-ended—and extremely expensive—proposition. AIG and Citigroup have both asked for one infusion of federal money, then another. Are they done? Or will they come back for even more? The $15 billion in federal loans for General Motors and Chrysler is almost certainly just a down payment on a bailout that could easily total $75 billion or more. And there’s no evidence at all that it will compel more people to buy their cars, which is the real problem. In the end, we might still be stuck with too many automakers building too many uncompetitive products.

So while systemic risk must always be addressed — and that is why I believe the Lehman bankruptcy was a major mistake — failure is part and parcel of the free market.  The government is not there to bail out companies that made poor decisions.  It is there to protect citizens from the ill effects of those poor decisions.

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Sources
Needed in 2009: More Failure – Rick Newman, U.S. News
Best Move of 2008: Letting Lehman Fail – Rick Newman, US News

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