Harvard Economist: Bankruptcy, not bailout, is the right answer

30 Sep 2008


I keep this blog focused on the CPA Exam and purposely don't delve into topical tangents like politics or other non-Exam related subjects. The CPA Exam however, tests on economics and business in general, as well as the obvious accounting topics that you would expect.

I also can't think of a more pressing and relevant topic for accountants to be informed on than the proposed “bailout” as it's called. As accountants and CPA Exam candidates we need to be informed and equipped to discuss the current financial mess with our peers and with those who expect us to have an opinion on the subject – i.e. your relatives and people who catch you in the hall at church.

“Hey, you're almost a CPA right? How are we going to fix this mess?”

If you listen to the media, there is only one solution – and it should have been put in place yesterday, and that is to go a trillion dollars into debt and force the taxpayers to clean up the mess of greedy people.

Here is another plan – and it involves (gulp) letting greedy people – not taxpayers suffer the consequences of their own actions.

“What? They'll be no credit! We'll all lose our jobs! The stock market will be worth zero!”

Not true.

Harvard Economist Jeffrey Miron writes:

“In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This “moral hazard” generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.”

There are pros and cons to every alternative. We need to be prepared to discuss them. CPA candidates must be somewhat competent on the subject.

Get the article here

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Anonymous 15 years ago

I think that the bailout won't do any miracles in this case. All these people (the golden boys) were carelessly and intentionally destroying the economy fundamentals, only to get their outrageous bonus paid. What did they do to worth that money? Ok, they work many hours and on weekends, but auditors also work many hours and on weekends and they get nothing in return. In the UK, an investment banker would get £40,000 as a first hire (with the potential to earn £100,000 in 2-3 years plus bonuses), while a junior in a big 4 firm would get £25,000. I don't see why we (US, UK, EU citizens) have to pay those people arrogance. I agree that bankcruptcy is not a good solution, but give them the bailout and let them pay for their own debts! Tax them heavily. I 've read that AIG directors went for SPA in CA, spending $$$$$, shortly after the AIG takeover. They continue to live a luxurious life, while the economic system worldwide collapses. No remorse, no sorrow. Arrogance again. In mythology, they call it hybris and whoever did this mistake was punished by the 3 Erinyes. I don't see any Erinyes coming after these people though. In the UK, RBS dared to complain to the government that saved her, that 25% preferrential dividend to the government is too much. I can't write anymore. You got my point.

Don 14 years ago

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