The Doomsday Cycle

Yesterday I mentioned that "the system" is broken, and I realize that is a gross overstatement of the obvious. But I want to be clear that I'm not just talking about the electoral system.

I'm referring to a socio-political system as a whole that allows -- actually encourages -- an unchecked collusion of industry and government. It is what will cause the eventual catastrophic decline of our Republic (if you can still call it that).

About a year ago, when we were in the heat of bailout fever, I was having a discussion with a friend of mine over lunch. We were trying to figure out whether the long term affects of bailing out companies that make poor management/business decisions was worth the short term gain of saving jobs.

You see in order for our system to work, failure is essential. Companies must be allowed to fail, to be punished for their failures by losing their assets and financial fortunes, in order to serve as an example to other companies of what happens when you employ risky business practices.

But, going back at least to the 1970s, we've seen more and more bailouts, followed by admonitions and vows to "never let this happen again," accompanied by additional layers of regulation.

But then when that regulation fails, additional bailouts are forthcoming, more regulation is added, and the cycle begins again. Businesses take bigger risks because they know the taxpayers will have to bail them out. In the case of the latest crisis, banks could be doubly assured of a bailout since Goldman Sachs has basically purchased the entire executive branch as well as key legislators.

The point, as Logtar stated in our lunch conversation, is that it's dangerous to socialize risk. But you don't need to take his for it.

In an editorial in Financial Times, superintelligent economists Peter Boone and Simon Johnson, gave a name to what is happening in the U.S. financial sector: the Doomsday Cycle.

They draw a parallel of the cycle described above -- risk, failure, bailout, repeat -- to what happened when the USSR finally imploded.

During the final years of communism’s decline, Soviet bureaucrats argued for futile tweaks to laws that would crack down on speculators and close “loopholes” – all in the vain hope they could keep the unproductive system of incentives intact. The US, UK and key European countries are now making the same errors. Rather than recognizing the dangerous systemic failures in our financial system, their leaders are proposing bandages that can – at best – only postpone another, possibly much larger, meltdown.

You should read the entire piece (free registration may be required). The authors make many good points, not the least of which is that the proposed wrist-slap or regulatory "reform" is nowhere near enough to limit bad business practices, let alone stop the Doomsday Cycle.

Rather, we need to make risky business behavior more painful by NOT BAILING BUSINESSES OUT!

tagged: politics, economy, bailouts, USSR, Doomsday Cycle, Goldman Sachs