Tuesday, October 19, 2010

Bail-outs are good, Hostile take-overs are bad, and everyone is a spectator

In any situation where anything is observed, there are as many opinions about the “facts” of the event as there are people that witnessed it. Generally, we can derive the “truth” by finding the consistencies in the stories and piece the event back together. I find it disappointing that I continue to find myself at a very different vantage point than the authors of almost every article we have read. That leaves me wondering if my own interpretation of reality or theirs that is flawed.
I believe that both of these authors are leaving out some very basic and important information about how the stock market works, how the banking systems work, and how to conduct a CBA in general. After trying to pick through the rhetoric about Acme and XYZ corporations, I am still unsure how Mr. Jasay thinks the stock market works. In my world, every single stock purchase is a speculation. So is every single act of entrepreneurship in which a person lays out capital in the pursuit of profits while exposing himself to risk. Every seller of a stock speculates it will decrease, every buyer speculates it will increase and in every transaction there is a winner and a loser. That is not the case in a normal market; the stock exchange truly is a zero sum game. The only thing I can give credit for is the realization that it is in fact animal spirits that create bubbles and busts, not some phantom credit creation monster. People make decisions based on the information they have, the expectations of costs and benefits, and the risk they are willing to bear. So long as those people are provided correct information (think Enron) about what they are buying and are able to identify the actual risks (think SEC ratings), then people should be required to accept losses when they knew the risk.
The natural rebuttal for that statement is going to be about bail-outs. Mr. Murphy, among many others, would like us to believe that we should allow the market to clear out the losers of what turns out to be bad decision making. Naturally, I agree with the logic. However, we must evaluate the impact of allowing such a situation to occur versus an intervention in terms of social welfare. The fact that past actions led to the current state become sunk costs when evaluating present decision making. Since we can clearly see that the negative impacts of allowing “the market to clear naturally” will not be neutralized but systemic, it is prudent to evaluate the costs of doing nothing versus the costs of doing something. When preforming that CBA, the obvious choice was to be proactive and deal with the moral hazard it creates in the future.
As a final point, if “raiders” where merely in existence to act as vultures, cannibalizing the salvage value of weakly performing firms, they provide no service at all. In that event, the same result would manifest without them when the firm shut down. The fact that they are still a company suggests that they are covering their short-run marginal costs. Killing them off early is as beneficial as euthanasia. Hostile takeovers are generally a pull to increase profits by disrupting competition. That is not in the best interest in anyone but the aspiring monopolist.

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