The Fed’s AIG Loan/Takeover: Another New Deal Legacy
By Robert Higgs on Sep 17, 2008 in Economics, Law, Money and Banking, The State
My idea of the ratchet effect in the growth of government, which I first described in detail in an article published in 1985 and employed extensively in my 1987 book Crisis and Leviathan, has received a degree of acceptance among scholars. One aspect of my model, however, has received relatively little notice, although I have always regarded it as especially important. That is the notion that episodes of crisis and abrupt growth of government leave legacies after the crisis has passed, and these legacies, which may be institutional or ideological, sometimes lie dormant for long periods before they exert effects on the course of events.
I thought immediately of this idea today as I read the Washington Post’s report of the Fed’s loan/takeover of the insurance giant AIG. Having heard preliminary discussions of the possibility of such a takeover, I had wondered about the government’s authority for such an action. The Post’s report answered my question as follows: “The Fed is using the emergency authority it was granted during the Great Depression. By law, the Fed can lend money to any individual, partnership or corporation in unusual and exigent circumstances, when the borrower cannot access funds in other ways. The power had not been exercised until March, when the Fed used it to rescue Bear Stearns.” I confess that I had not known about this particular Fed authority until today.
So, here we are in the year 2008, witnessing the use of a power that had lain dormant in the government’s arsenal for more than 70 years, a power whose existence, I am confident, few people were aware of. Beware, all ye who would endow the state with amplified powers. It may refrain from using those powers for a very long time. Yet, there they lie, sleeping peacefully, but capable of being awakened and used with highly consequential (and, as in this case, extremely unfortunate) effect.
Bob, the market dropped another 4% today after the government announced its decision to loan/takeover AIG. You have also written how regime uncertainty lengthened the depression. Is this government action destabilizing the market?
Martin Buerger | Sep 17, 2008 | Reply
Yes, Martin, I believe the AIG loan/takeover does have a destabilizing effect. It comes close on the heels of the government’s declining to save Lehman Brothers. So now everyone is wondering: whom will the government bail out, and whom will it not bail out? This situation creates uncertainty for all who deal with any troubled firm.
Roger Garrison has argued for years that a major effect of the Fed’s interest-rate setting is to create uncertainty: what will the Fed do next with the Fed funds rate, everyone tries to guess. When the Fed and the Treasury expand the scope of their lending, as they have recently, this sort of uncertainty is compounded.
Robert Higgs | Sep 17, 2008 | Reply
I thought the best short comment on the bail out (…or ‘bail up’, at least as far as taxpayers are concerned…) comes from ‘Marginal Revolution’s’ Alex Tabarrok.
“Thanks goodness we bailed out Bear Stearns back in March if we hadn’t we might have lost Fannie Mae and Freddie Mac, Lehman Brothers, Merrill Lynch and who knows what else. Oh wait…”
Tim | Sep 18, 2008 | Reply
and if no such provision had existed — the bailouts would have gone ahead.
i suspect that throwing enough law clerks on research also retrieved other statutes that would have served just as well.
who knows perhaps the sleeping serpent might have been found in a source more in-line with your ideological presuppositions.
bipolar2 | Sep 18, 2008 | Reply
“who knows perhaps the sleeping serpent might have been found in a source more in-line with your ideological presuppositions.”
? That seems unlikely, seeing as how if I’m not mistaken Higgs’ “ideological presuppositions” hold that the Fed, Fanny and Freddie as well as all government regulations and subsidies and bailouts and takeovers are all illegitimate. Do you think they’d find a statute somewhere for that? I doubt it.
Geoffrey Allan Plauche | Sep 18, 2008 | Reply
The AIG bailout was necessary because the alternative was too horrible to contemplate.
But it was caused because AIG was too big to fail, because the government failed for years to enforce the Anti-Trust laws.
Allowing a few companies to use a huge amount of leverage to buy up a majority of the assets of a critical industry was stupid, and against the law.
This, I am sorry to say, is a major failure of the REPUBLICAN party. Yeah, that’s right, my party.
There has, for years been hostility to the idea of Anti-trust. People who have not learned their Adam Smith are destined to keep repeating the mistakes of the past.
kyle N | Sep 18, 2008 | Reply
Hi webmaster!
Kazeljht | Sep 19, 2008 | Reply
This is the first reference I’ve read to the anti-trust laws – it seems as though such areference would immediately come to mind. When I discovered that action based on anti-trust would be initiated in the justice department-and I considered the behaviour of the justice dept. operatives in the past 8 years- I understood the odd situation.
rosemary nolan | Sep 23, 2008 | Reply