I have always liked Larry Kudlow. When I was growing up as a budding free marketeer, there was a natural disaster (I don’t remember which one) and everyone was calling for the president (must have been Reagan) to disburse disaster assistance for rebuilding. I didn’t like that answer, but I didn’t know how to argue against it except through appeal to property rights. I was elated, then, when Kudlow was on some talking heads show and explained the problem of moral hazard.
Well, I am sad to report that Larry Kudlow has abandoned his earlier principles. I’m not necessarily saying he took a behind-the-scenes payment to flip flop on the bailout, but the quotes below speak for themselves.
In his latest column Kudlow wrote:
Paradoxical as it may be, strong government actions to stabilize banking are necessary to preserve the free-market-economy system. No free-market economy can survive without stable banking and credit. Without readily available credit, entrepreneurs can’t put their new ideas into commercial practice. And without that vital innovation, economic growth suffers.
The trick now is to use government levers in smart and efficient ways. Banks need to be recapitalized without punishing current and future shareholders. Henry Paulson is working on this.
Put aside Kudlow’s blank check for government interference. What is most interesting in the above excerpt is Kudlow’s complete disregard for the moral hazard problem, i.e. for rewarding shareholders of companies that made risky investments during the real estate boom. Well, maybe Kudlow isn’t aware of the problem?
Ah, that’s not it. In an article less than a month ago at National Review Online, Kudlow told us:
Treasury Secretary Henry Paulson is the man of the hour. This weekend he drew a clear line in the sand: no more federal bailouts. Not for Lehman Brothers. Not for global insurer AIG. Not for Merrill Lynch. Not for anyone, at least as of this writing.
Last March, acting in conjunction with Fed head Ben Bernanke, Paulson safeguarded the banking system and the whole global financial structure by backstopping a JPMorgan-Chase deal to acquire the ailing Bear Stearns with $29 billion of loan guarantees. The action succeeded in stabilizing markets, but it put U.S. taxpayers on the hook big-time.
So this time around, as the Lehman stock headed for zero, Paulson said enough is enough.
Paulson’s view…is that the private sector has to take responsibility, including a consortium of private bank funds to assist the beleaguered AIG insurance company. We are now in for some Schumpeterian gales of creative destruction. But this is how it must be.
“Moral hazard,” said Paulson, “is something I don’t take lightly.” He’s saying bad financial behavior must be penalized, not rewarded. That’s the essence of the issue. The risk of failure is essential to an efficient economic system, and that includes financial risk.
In our capitalist system there are losers as well as winners. There are failures as well as successes. Harking back to the eminent economist Joseph Schumpeter, the old failures will be replaced by new enterprises.
The alternative, of course, is that the U.S. goes down the old European path of government domination of markets and the economy. But the moment the U.S. becomes bailout nation, that is the moment our economy and country heads irrevocably down the road of decline. However, Paulson set down a marker and said, “No we won’t.” As difficult as the next days may be, the primacy of economic freedom has been given a boost while the economic future of the U.S. looks brighter. Paulson’s decision was both momentous and transformative.
(I apologize, Mrs. Kudlow, if you’re reading and this embarrasses you, but it couldn’t be helped. I’m sure your son has a good explanation for all this. And when you talk to him, please ask why he said he wouldn’t support the bailout if it included limits on executive pay, but then supported it enthusiastically two days later…even though it included limits on executive pay.)
Free Advice readers will enjoy this final excerpt. After explaining why moral hazard is the decisive issue here, and how Paulson put down a marker to prevent us from going down the road to decline, Kudlow takes on the Democrats:
Obama is on the campaign trail predictably charging that a lack of regulations during the Bush era is responsible for the current mess. But he’s misreading history. As George Mason economist Tyler Cowen wrote in the New York Times, one of the problems with the U.S. financial system is not a lack of regulation, but a lack of smart and effective regulation.
Ah, the circle is complete. A wuss free marketeer who cheerleads the literal socialization of the financial sector, citing Tyler Cowen to back up his view that our problems are due to lack of smart and effective government regulation. Arrrrgh! At this point, I am waiting for Ashton Kutcher to jump out and hug me.