Current policy is all geared towards putting the economic genie back in the bottle. And through massive government intervention, we may yet restore our banking system to “health” and perhaps they will, for a while, be profitable lenders again.
But remember, the old system was proven to be horrible and corrupt. If it collapses again, the government will be forced to try more bailouts — but with even less credibility and a bigger debt load to service.
I sympathize with the point of view which says that the political window of opportunity is narrow and the need for action urgent, so let’s accept the bailout plan for now, and deal with these wider issues later on. But the very fact that political momentum is limited means that if these wider changes are to be brought about, the process has to begin in earnest at once. Does anyone seriously believe that in a years time, if following massive government support the banks are stable – or can be made to appear stable – there will be any political will to break up very large institutions, or any real change to underlying norms in the financial sector?
However, absent these deeper changes, it is entirely possible that we will see a replay of the crisis – but on a larger scale – in a few years time. Naturally, one cannot say with certainty that such a cataclysm (and if it were much larger than the current crisis, it really would be a cataclysm) will occur. But if it does, the resulting costs will be huge. Martin Wolf has written persuasively about the costs of major economic dislocation. Net of unemployment, political instability and even wars, the human costs of a sequel could dwarf even the current crisis. Then, the choice in the present between the “bailout” and “restructuring” plans hinges on whether expected cost (in the broadest sense), conditioned on the “bailout” strategy is higher than expected cost conditioned on “restructuring”. One could formalise this argument as a decision problem, but it comes down to a judgement call on the relative probability of such a cataclysm under the two strategies and the magnitude of the dislocation. My feeling, admittedly subjective, is that the gloomy cataclysm scenario is substantially more likely under the “bailout” than “restructuring”, and that the costs would be immense.
This case can be put very simply: if we do not use current political momentum to fundamentally reform a system which has shown itself to be unstable and even dangerous, a second opportunity may come at a very high price. And this is not a gamble I wish to see our leaders make.
The thing to remember in all this is that 2005-2007 was not a boom time. It may have felt like one, but it was a period characterised by massive misuse of capital and poor decision making. It was a period during which an inordinate amount of wealth was sucked up by the financial sector, with minimal benefit for anyone else. There was jut no way for that to persist and it had to end violently. Trying to stuff that back up, with the government even more wed to the financial industry, may mean our worst years are ahead of us — even if things start to feel stable again.