Washington DC, March 18, 2008 --  

The regular use of credit spending to hide failure is casting a shadow over America's economic future.

The Federal Reserve's $30 billion bailout of investment firm Bear Stearns is but the latest irresponsible act by American officials who seem hell-bent on destroying the country's finances. The deal will provide financial cover for huge losses on the firm's mortgage investments to enable its absorption by financial powerhouse JP Morgan, and supposedly shore up confidence in the American financial industry.¹

Outrage over this bailout, however, has largely been limited to left-leaning Americans who think mom and pop homeowners facing mortgage defaults (for their own irresponsible buying behavior) should receive the $30 billion in bailout money instead of a big Wall Street company. With most Americans are arguing about which irresponsible people deserve a government bailout, I offer a simple compromise: Let them all fail.

Using $30 billion to prevent an irresponsible company from failing is exactly the opposite of what America's financial system needs. With the American dollar already at historic lows against the euro and the yen, shoveling an extra $30 billion into the money supply is only going to make things worse. More importantly, spending this money to protect a firm that has engaged in irresponsible financial behavior -- betting the company on risky mortgages in a housing bubble -- provides a disincentive for responsible behavior in America's economy.

This is what economists call "moral hazard." Only if people suffer the consequences from making bad decisions will they alter their behavior in the future. By refusing to allow Bear Stearns to collapse from taking bad risks, the Federal Reserve has struck a blow to moral hazard in financial markets. This would be bad enough if it were an isolated incident, but the refusal to allow failure despite irresponsible actions -- and to throw good money after bad -- has become a prominent feature in America today.

• Bet your company on irresponsibly risky investments? No problem -- the Fed will bail you out.
• Irresponsibly buy a house you can't afford? No problem -- the government will provide relief.
• Elect leaders to wage an expensive war that your fellow taxpayers won't fund? No problem -- the government will just take out loans from the Chinese to pay for it.

And it's the latter case, that of the Iraq War, that is the biggest case of bypassed moral hazard in world history. A new book by a Nobel Prize-winning economist estimates the ultimate cost of the war at a staggering $3 trillion -- $10,000 for every man woman and child in the United States.²

Stunningly, this enormous cost has been hidden from taxpayers. Previous wars have been paid for by raising taxes (Vietnam), or selling war bonds (World War I and World War II).

But the Iraq war has been paid for entirely on credit, meaning that that Bush administration and its dwindling cadre of die-hard war supporters have been effectively bailed out from facing the wrath of outraged taxpayers who would otherwise revolt against paying the $10,000 per person price tag -- especially since they were once promised that Iraqi oil would pay for the country's reconstruction. Like Bear Stearns on a much larger scale, massive amounts of borrowed money are being used to keep irresponsible policy from failing.

So long as American officials keep rewarding dysfunctional behavior through dollar-pummeling credit spending, critical restructuring and policy reform will be frozen dead in their tracks. And the responsible minority -- those who live within their means, avoid big financial risks, and oppose unnecessary and ill-conceived wars, will equally share the pain of inflation as the dollar continues its slide against foreign currencies. As long as America continues to live under this tyranny of the irresponsible, its future will look bleak indeed.

Related Web Columns:

House of Cards
The Collapse of Credit-Driven Spending, March 18, 2008

Victimized by an Idiotic Mob, October 2, 2007

Spending Away the Dollar, December 7, 2004

1. Associated Press, JP Morgan to Buy Bear for $2 a Share, March 16, 2008

2. Washington Post, The Iraq War Will Cost Us $3 Trillion, and Much More, March 16, 2008