Wednesday, 25 February 2009
Some commenters on Stephanie Flanders' blog (and of course in other places) are suggesting the banks simply be liquidated - no nationalisation, no bailouts.
This has the appeal of being fair - creditors who made bad decisions lose money.
But it may not make the system work well. If it destroys liquidity and causes people to become irrationally risk-averse, then justice may be served at the expense of the common good. By forcing a subset of creditors to take a hit to their assets - particularly those which are liquid and immediately available - we might cause knock-on effects which would destroy far more economic value than the counterfactual, the cost of a bank bailout. This is what the phrase 'cut off your nose to spite your face' was invented for.
It's impossible to know for sure what would happen if we did let banks fail. Some people are working out ideas on this. But the feeling in government is clearly that the damage would be so great that it's worth putting hundreds of billions in public money at risk to prevent it.
Could it ever be otherwise? What criteria (and what definition of justice) would specify an economic system where justice and utilitarianism always coincide? Where the means and the ends are always consistent? Could such a system exist? Your comments on this are very welcome.