Bailout: Theory and Crisis

Theory and Crisis

Any bailout plan that is believed to be potentially effective must be based on a theory. Otherwise it would merely be a shot in the dark. If you asked a TARP advocate why the intervention is necessary, he presumably would explain the problem and how the bailout would remedy it. For example, he might say that when the government borrows $700 billion in order to buy banks' bad mortgage-backed securities, it will inject liquidity into the credit markets and improve the economy. But that is a theory. (It's a bad theory, but it is a theory.)...

Free-market theory can explain the cause of the crisis -- government intervention in the mortgage market through promotion of easy home-buying and implicit guarantees to lenders and underwriters, including its privileged creatures, Fannie Mae and Freddie Mac. Given that genesis of the problems and the general theory of markets, the solution is for government to back off -- way off -- and to let the economy adjust to real conditions and recover without subsidy, guarantee, or regulation.

What is the alternative theory used by those who have jettisoned free-market theory in "this time of crisis"? Why should we believe that things will be fine only if the government has the discretionary power to transfer resources from those who haven't screwed up to those who have?

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My thoughts: Markets work, socialism does not.