Using strict statistical methods, I have calculated that my productivity has dropped by a record 8% in the last 48 hours while I try and sort through the financial nightmare that is terrorizing some major money moguls as we speak. The latest victim is AIG, which just ceded an 80% stake to The Federal Reserve (yikes) for a barely fathomable $85 billion.
Historically, the government has identified industries that are too big or too important to fail. Amtrak and the airlines both have enjoyed government favoritism to some extent. But the financial industry is in a class by itself. The Federal Reserve came in 1913, and the FDIC came in 1933, creating a foundation for a system that now allows firms to make stupid decisions and people to obtain stupid loans.
In case you didn't realize this by now, with public goods being the notable exception, when the government gets involved in industry it screws everything up, and necessarily produces a result inferior to that of the private market. What incentive do banks have to make responsible loans if the government is going to bail them out?
As an economics student, I learned the virtues of the Fed. After all, countries need central banks. But, the Fed's purposes have evolved. Originally meant to control bank panics, it became a regulatory agency for banks, a monetary policy instrument, and a lender of last resort to banks. There has been some history of the Fed serving as a mediator and broker for emergency rescues of too-big-to-fail financial institutions, with Long Term Capital Management being perhaps the most noteworthy. But in the last 6 months, the Fed has pushed even that boundary and has acted a lender of last resort to investment banks (not regular banks), and now, today, has apparently nationalized the nation's largest insurer! Not only are we taxpayers on the hook for the first $85 billion, but I'm quite sure AIG is about to shell out infinity billion dollars to rebuild Texas from Hurricane Ike--are we going to have to pay for that too?!!!!
If that weren't scary enough, consider this: at some point, the Democrat Congress is going to realize that they now have an 80% stake in an insurance company. Democrats want national health insurance. Get the picture?
I hope to research a mega-post on this, but in case I don't, here's what I'm thinking. Most of this is the fault of Democrats, not of the free market or capitalism. Democrats created Fannie Mae and Freddy Mac, and Democrats ran those agencies into the ground while cooking the books and pocketing tens of millions of dollars. When President Bush tried to reform those agencies in 2003 (I think), Democrats blocked it. Fannie and Freddie gave millions of lobbying dollars to Democrats (Obama, Hillary, and Biden were all in the top 5 I think...McCain was #342)--which essentially means the government was lobbying the Democrat part of itself--and we can now see why.
Even so, I am not happy with the Bush administration. That itwould allow such an overt breach of free-market principles is horrible. If the Fed did this unilaterally using its independence, then we need to find limits to the Fed's powers outside of monetary policy. To borrow terminology from Warren Buffet, we the taxpayers are throwing good money after bad money, and we didn't have an ounce of say about it. Earlier in the post I announced that the latest victim was AIG, but the true victim is us.