06.20.2011 1

Bailouts Erode Confidence in Value

By Bill Wilson – What is the price of a bailout? Nominally, it’s how much a central bank or legislature has to print or spend, respectively, to save a failed institution from its own stupidity.

For example, the Treasury has dedicated more than $150 billion to bailing out Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. Or, the Federal Reserve printed $1.25 trillion to buy mortgage-backed securities from financial institutions all over the world.

However, the cost of the many bailouts that have taken place since 2008 may be more far-reaching than just adding the national debt or blowing up the Fed’s balance sheet.

The ultimate cost may be in eroding any confidence at all in the value of money.

When institutions bet poorly, whether it be on housing or sovereign debt, and stand to lose hundreds of billions of dollars, and then a printing press intervenes to save them, it takes risk out of the equation when assessing the value of these and other assets.

When your neighbor gets a bailout on his mortgage, what is the value of your own mortgage payments? Why make any payments at all? What is the value of the taxes you pay when the banks that lend governments money are made whole even when those governments cannot refinance those loans? Why bother paying taxes?

After the United States officially came off of the gold standard under Richard Nixon, the value of the dollar has been said to be in the productivity of the American worker. Money, then, was a unit of measure of how much an employee’s work shift is worth to an employer.

In extension, workers, when they use their wages to purchase goods and services, are then exchanging their time spent at work for the things they need and want. Therefore, the more valuable an individual is deemed by his or her employer, the greater that person’s purchasing power is. And, the more productive the American workforce is as a whole, the more valuable the dollar would become.

But these bailouts — and the fractional banking system that has necessitated them in the eyes of public officials — have thrown all of that into question. How?

Systemic risk. Because financial institutions have overleveraged themselves on loans, investments, and other securities, and because there is an interconnected counterparty risk between these institutions, the collapse in the value of a particular asset or of a particular institution is thought to threaten the solvency of the wider financial system.

That is the only plausible explanation for the 2008 bailouts, and it is certainly the only explanation for what is taking place today in Europe, where any proposal that unsecured creditors take losses on sovereign debt is kyboshed.

So overleveraged and interconnected is this system, a default by Greece, which accounts for less than 1 percent of the global economy, now threatens to take down the entire financial system. How can this be?

Greece carries a gross debt of €340 billion. Of that, German and French banks own about €15.5 billion and €10.28 billion, respectively, meaning a default would hit them particularly hard, too. The European Central Bank (ECB) is on the hook directly for over €120 billion in Greek debt, including tens of billions of Greek debt it accepted as collateral when making other loans.

If these international financial institutions take losses of that magnitude, it will mean less money to lend to other sovereigns. Their failure will mean the defaults of other sovereigns like Ireland, Portugal, Italy, Spain, and so forth. Those defaults will in turn take down other financial institutions that lent them money.

So, the European Union, International Monetary Fund, and the ECB have all intervened to bail out the creditors of these troubled sovereigns — with yet more printed money.

The people ask: If central banks like the ECB or the Fed can just print trillions to paper over these debts, without any risk of default, what is the sense of paying taxes at all? In the case of a bank, what is the sense of asking for any collateral on a loan? Why even bother charging any interest on these loans?

If a printing press is all that is necessary for a government to spend unlimited amounts of money on social spending or for houses to be bought and sold, why even make loans at all? Why have any debt? Why not just print all of that money and let everyone live debt free? Why even work?

If failure is no longer allowed in the economy, then there is no risk.

But we know that there is risk, huge risk, for the average person. The worker or the small businessman or the professional face stiff penalties for mistakes or failure to pay their obligations. So, the real question is who is freed of any risk and loss for mistakes and who is forced to pay the bills – for themselves and for the anointed elite? And the bigger question yet, who decides?

The current crisis we find ourselves in will not begin to honestly repair itself until real value is returned to our money. And to do that, risk must be applied across the board. There must be a risk faced by those international bankers and financial gurus. If they bet wrong, they should pay. It applies to nations as well. If Greece cannot afford its semi-socialist welfare state, then it must pay the piper. So too the United States. The good-intentioned, ill-conceived welfare state is killing us.

The printing presses at the Federal Reserve and elsewhere are devaluing our money and thereby stealing our time spent in labor and productive activity. Value and risk must return or we are surely headed over the cliff.

Bill Wilson is the President of Americans for Limited Government. You cna follow Bill on Twitter at @BillWilsonALG.

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