Brodie's Public Policy and Global Governance Blog

With news of the stalled bailout deal worth $700 billion an old adage comes to mind - what goes around comes around.  The debate over whether or not to bail out ailing U.S. banks and insurers reeks of the rhetoric surrounding the 1997 Asian financial crisis that wreaked havoc on the "Asian Tigers" as the Thai bhat collapsed and spread financial chaos across the globe. The worst hit countries and those willing to accept strict conditions of fiscal austerity and the dismantling of capital controls were bailed out while others were left to suffer the misery of financial crisis contagion.

As in 1997, the current debate is focused around what many call a "moral hazard." If banks and insurers can rely on the fact that the government will bail them out in the interest of the American public and the financial system as a whole, this creates a moral hazard in that these institutions may not act as prudently as they would otherwise knowing that they will be bailed out should they get into trouble. In the financial world this concern is especially pronounced. Risky financial transactions can be mean ruin for a bank or insurer but risk can also mean large payoffs. If investors know that they will be bailed out should they get themselves into trouble this risky behaviour may become more prevalent.

This line of reasoning seems to resonate not only with many of those in office, but also the general public. Polls suggest that over 50% of Americans do not beleive that their government should be bailing out financial institutions for their poor decisions. Bush himself was orginally against the idea of bailing out some of the biggest financial institutions on Wall Street but it seems that the damage of not bailing these banks may be worse than letting them die. However, financial experts suggest that the bailouts will only prolong the inevitable slide of U.S. markets making the financial crisis last even longer.

With so much focus on the financial crisis it is hard to distinguish signal from noise and come to a conclusion on what the appropriate course of action should be. More often than not the response to financial crisis seems to result from the idiosyncracies of decisionmakers rather than empirical evidence. Just as the bailouts of 1997 appeared to be incredibly selective so have those for Wall Street giants. It seems that history is destined to repeat itself only this time it is those in Washington who are being told that they will have to clean up their own mess.