May 1, 2008 [LINK / comment]

"Worst decision" by the Fed?

I was very dubious of the buyout of Bear Stearns by J.P. Morgan, made possible by emergency financial support from the Federal Reserve, but a former senior policy adviser made an exceptionally harsh criticism of the March 14 move. Vincent Reinhart, who advised Federal Reserve Chairman Ben Bernanke as well as his predecessor Alan Greenspan, called that rescue operation the "worst policy decision in a generation." Gone is the pretense that the Fed serves as an "honest broker" in preserving monetary stability. What's worse is that the Fed plans to start making loans to investment banks, going outside its traditional domain of depository institutions. Getting involved in such a high-risk sector sets a very bad precedent for the future. See Washington Post.

We need to remember the close connection between market economics and individual freedom, and that capitalism fosters liberty only as long as the government is restrained from playing favorites. Once it starts intervening for the sake of stability, there is a slippery slope and it gets hard to avoid getting ever-more deeply entangled in business affairs. The "moral hazard" that arises whenever the Fed makes emergency loans -- insulating firms and individuals from the consequences of their bad decisions -- has been forgotten by most people. Once voters get used to the idea that politicians can be induced to help them out in time of "need," then we have turned away from our (small r) republican roots and embraced the comforting allure of despotism. "Crony capitalism" or "compassionate conservatism" -- whichever way you look at it, the whole thing stinks like rotten eggs.