Spend in haste, repent at leisure: America’s latest bailout plan

The Treasury's rescue plan is misguided, because, unlike in the 1930's, the US faces a hypertrophied financial system. Rather than causing a Great Depression, significant shrinkage of the financial sector, particularly if facilitated by an improved regulatory structure, might actually enhance efficiency and growth.

Cambridge – With minds concentrated by fears of another 1930’s-style Great Depression, America’s politicians have adopted, virtually overnight, a $700 billon bailout plan to resuscitate the country’s rapidly deflating financial sector. The final deal is an elaborate piece of financial and political engineering whose ultimate effect is almost impossible to predict. There are good reasons, however, to be skeptical that this will be the panacea that credit markets are (literally) banking on.

The plan’s central conceit is that government ingenuity can disentangle the trillion-dollar “sub-prime” mortgage loan market, even though Wall Street’s own rocket scientists have utterly failed to do so. To boot, we are told that government is so clever that it might even make money on the whole affair. Perhaps, but let’s not forget that a lot of very smart people in the financial industry thought the same thing until quite recently.

Just a year ago, the United States had five major freestanding investment banks that stood atop its mighty financial sector. Collectively, their employees shared more than $36 billion dollars in bonuses last year, thanks to the huge profits these institutions “earned” on their risky and aggressive business strategies. These strategies typically involve far more risk – and sophistication – than the activities of traditional commercial banks.

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