Good can come from failure. Abraham Lincoln’s failure to capture a Senate seat set the stage for his presidential run. Winston Churchill’s failure at Gallipoli prepared him for the strategic challenges of WW II. Recognizing failure and trying to move forward is almost always better than pretending that you haven’t really failed.
So why is the federal government preventing the failure of financial firms, such as AIG or Bear Stearns? Providing government loans to AIG or guaranteeing the buyer of Bear Stearns against loss did not alter any of the financial reality. Nothing new was produced or created. No new capital was created; it was simply transferred from taxpayers (either by contributing to inflation or by adding to national debt) to people who do work for or business with these firms.
Conversely, if these firms had instead been allowed to fail by going bankrupt nothing would have been destroyed. All of the financial capital held by these firms would still exist. And all of the human capital of the people who works for those firms would still exist. Bankruptcy doesn’t mean that you take all of the capital of a firm, put it in a pile, and blow it up. It’s all still there. What bankruptcy does is it forces people to reorganize what they will do with that financial and human capital. That is, they are forces to recognize their failure and figure out a better way to do things.
And even more importantly, failure forces people involved with these firms to experience the consequences of their actions. Those people — and everyone else — learns from those consequences and hopefully changes their behavior in the future. To prevent failure is to prevent learning.
The same is true for schools. Good can come from failure. Of course, we’d prefer to avoid failure, if at all possible. But if the reality is that students or educators or schools have failed, then insulating people from that reality doesn’t do anyone any favors. No new knowledge is created by hiding failure and none is destroyed by recognizing it. Admitting that students, educators, or schools have failed allows us to reorganize how we do things and to all learn important lessons.
Jay P. Greene's Blog 
I saw a railway ad in New York once that had a picture of Abraham Lincoln with the caption: “Failure. Failure. Failure. Failure. And then . . .”
Note: For the benefit of those who had this teacher, Abraham Lincoln was the 16th president of the United States.
I’m with you in general. Bankruptcy is good, etc. But…
I haven’t quite wrapped my head aroudn whether bailing out AIG was a good idea or not. However, I do agree with WSJ that it is a real problem that all of this is happening behind closed doors and at the whim of the Treasory secretary and the fact that it is all being put together by the seat of everyones pants is worrysome.
I’m no finance expert, so I may be quite wrong, but in this case, I don’t think it is as simple as not “blowing up” the assets. The problem is the chain reaction — AIG goes under and thus is no longer able to insure against the mortgage securities — this necessarily increases the risk of these securities for the holders, who are then required to raise additional capital in order to cover their bets, which they most often must do by selling assets — this reduces the value of those firms, and leads to the downgrade of their paper — which impacts the holders of that paper — and the cycle continues and continues for who knows how long.
Like I said, I still haven’t decided whether I think this is a good idea. Either way, I’m scared.
There can be chain reactions to failure, but those reactions represent other failures. People bought mortgage bond insurance from AIG without fully considering the possibility that AIG might be unable to deliver on its end of the bargain. To protect these folks who ignored counter-party risk prevents them from experiencing the consequences of their actions and prevents learning (it creates moral harzard for the future). And to protect those folks against the consequences just means tranferring wealth from taxpayers to them. That is, the chain reaction will take place no matter what, It’s just a question of who is going to pay for it — those who took the risks and experienced benefits or everyone else.
I suppose people could try to justify the bailout by saying that it prevents an irrational panic, But whose to say that it is irrational? The government isn’t a particularly savvy investor nor should we expext it to be any better at managing the companies that it has now acquired.
agreed — there is a moral hazzard here — one of the reasons that I’m still undecided whether it is good (as if my decision mattered).
however, it’s not necessarily true that someone must pay here – though that may be where we are going — AIG has lots of assets to sell to back their position but those assests are not liquid enough for them to do so in time to meet a credit crunch happening immediately — the idea is to buy them time to raise the capital, in which case no unravelling may be necessary. That is, the AIG value is actually higher than it is on the books right now, but it is being depressed because if they fail to meet a short term requirement all becomes lost. If those assets were sold now, they would be sold for a value far lower than their true worth because of their illiquid nature — that true value woudl be acquired by whoever takes it on, but the AIG unravels everything story would happen when it needent.
I think….
But to make this argument you’d have to know that the market is currently wrong in assessing the value of AIG’s assets and that the government is good at judging what the true value of those assets is.
If we accepted this argument more broadly the government should regularly engage in arbitrage to correct mis-pricing in the market. They could operate a hedge fund and make a profit. : )
I haven’t read or heard anything disputing the underlying value of those assets — all the discussion I’ve heard is about their liquidity.
Hey, Jay, Mike Petrilli had the same idea you did.
oops. I hadn’t seen that. I guess great minds think alike. : )
The AIG takeover is much more benign than the Paulson $700 billion plan for taxpayers and moral hazard. The government loan is secured and will be paid back first. Shareholdders, bond holders and counterparties will be paid beack afterwards. It was meant to stop the contagion effect. Unfortunately, it didn’t have the desired reaction as investors lost faith in Morgan Stanley and Goldman Sachs This is why Paulson went for his current plan. I think he has gone too far. I fear that the government will over pay for the mortgage assets. Let’s see what the final legislation says.
I agree. It’s gone from awful to more awful. The government cannot operate as a hedge fund, trying to buy assets on the cheap, stabilize them, and then sell them. This is just a giant transfer of wealth from taxpayers to employees and investors in these financial institutions.
I can’t keep up. When I was younger and more idealistic I entertained these kinds of notions, but ultimately lost faith in visions of a utopia that relied on government coercion. Now socialism is back in style? I guess I’ll never be cool.
Well when I was younger Republicans took back Congress claiming to be “fiscal conservatives” and Democrats had all the good sex scandals. A lot can happen in a decade and a half.
[…] short, the banks miscalculated that they had engineered away failure. Jay P. Greene’s post In Defence of Failure provides an articulate prescription to Lanchester’s […]