Does Bear Stearns Bailout Set a Bad Precedent?

Wall Street is all about profit. All about the bottom line. And profit does play a major role in making our world go round. Without profit, there's no point in taking risks. Without risk-taking, there's no investment. Without investment, there's no growth. Profits are the cornerstone of our economy and our way of life.

But as Milton Friedman liked to point out, our economic system isn't just based on profit. It's a profit and loss system. It's the combination that sustains and enhances our standard of living.

Yes, the potential for profit encourages people to take risks. But without the potential for loss, you have reckless risk-taking. You have risk-taking without prudence. Without the potential for loss, irresponsibility goes unpunished.

The Federal Reserve and the Treasury Department have orchestrated the rescue of Bear Stearns. The defenders of that maneuver argue that if Bear Stearns had failed it would have created a lot of collateral damage, so much collateral damage, that you and I, normal folk who don't know anything about high-falutin' financial instruments like "collateralized debt obligations" would have been engulfed as well. If Bear Stearns had gone bankrupt, Lehman Brothers might have been next.

Some say that if Bear Stearns had failed, the entire banking system was at risk.

Maybe.

It seems awfully hard to know for sure.

But what I do know for sure is that by subsidizing the marriage of Bear Stearns and JP Morgan, the government has removed some of the loss from the profit and loss system. Oh, they tried to make Bear Stearns suffer by demanding a price of $2 a share. But now the deal has been renegotiated—ta-da!—to $10 a share, a mere five-fold readjustment.

What's going on here?

What's going on here is that we're in uncharted territory, a world where the Fed and the Treasury are making up the rules as they go along, where accountability is being ignored and a world where the government bails out Bear Stearns and its creditors rather than letting those who have been reckless learn a lesson for the next time.

Yes, letting Bear Stearns go under would have been dangerous. But helping JP Morgan devour Bear Stearns is dangerous, too. Where does the government stop in protecting people from irresponsibility? Home owners and lenders are next. The political pressure is inexorable for some sort of bail out. And then comes more regulation of investment banks.

In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We've encouraged more people to make more bad decisions in the future. The real price to be paid

isn't the dollar costs of any bail out, but the encouragement of recklessness and irresponsibility. That will make all of us poorer down the road.

Russell Roberts is a professor at George Mason University and a research fellow at Stanford University's Hoover Institution. He hosts the weekly podcast series, EconTalk.

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