Sunday, September 21, 2008

The High Cost of Bailouts Lies Ahead

Fortune Magazine says rather than government intervention, the financial industry needs consolidation:
Henry Paulson and Ben Bernanke have saved us, for now, from a market meltdown — but at the cost of allowing the folks who caused the current crisis to keep ducking reality. ...

The Treasury secretary and Federal Reserve chairman have spent September dashing off blank check after blank check in a bid to quell turbulent markets. ...

Ultimately, what could prove to be the most expensive aspect of the bailout spree is the message the government is sending to firms in which the market has lost confidence. Prudent management, it seems, will be punished, while the status quo — however unhealthy — must be maintained at all costs.

The strong stock-market rally of the past two days aside, intervention that fails to foster a shakeout of weaker firms will only delay the reckoning that must occur before a sustainable economic recovery can take shape.

"We continue to believe that the financial sector is in need of massive consolidation because the sector simply has too much lending capacity left over from the credit bubble," Merrill Lynch investment strategist Rich Bernstein writes Friday. "History shows well that consolidation is the primary driver of post-bubble economies." ...

Though the free fall in financial shares over recent weeks wasn't pretty to watch, it had the sanguine effect of forcing businesses with questionable fundamentals to confront an uncertain future. ...

But for the rest of us, the feds' rush to defend teetering financial firms only defers the tough decisions that will need to be made before this crisis subsides — at the expense, perhaps, of repeating Japan's so-called lost decade of economic stagnance after its property bubble collapsed around 1990.

History shows that setting up bad banks without forcing financial firms' managers to confront their problems won't solve anything.

"This seems to us," Bernstein writes, "to be a very Japanese approach to solving a credit crisis."
Fortune Magazine obviously disagrees with The Wall Street Journal about whether we're repeating Japan's mistakes. We don't need to keep guessing who is right. In time, we'll all know the answer.

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