Earlier quoted context omitted.
The failure has not been prevented, it has merely been postponed to a point at which it will be vastly worse. This is a fundamental misunderstanding of economics that politicians tend to have. You can't spend money and change history, all you can do is let the errors f the past be worked out via natural processes, like bankruptcy. If we had liquidated all those fraudulent securities we would have a stronger economy t…
I think you're misapprehending my point (and I wasn't all that clear or let alone detailed). I agree 100% that deleveraging is what's required, the liquidation of all these bad investments (and for that matter that's what the Austrians recommend). Here I'm talking about timing and secondary effects. There's a big difference between this effectively happening all at once as banks and other institutions refuse to do bu…
My point, which may have gotten away as well, is that there will always be a rationalization for the claim that "if we don't act now, the whole system will seize up and it will be a catastrophe!"
I believe this is a perspective that is popular among politicians because it gives them a chance to take Bold Swift Action in the Face of Danger.
But it fails to understand what markets are. Markets, if allowed to operate, will reprice correctly, and pretty quickly, things that are mis-priced.
Thus we can have a huge change in the market price of some particular asset due to new information--- and here's the point-- but we then have a new price.
Politicians think that achieving this new price, eg, the price drop, is the calamity. But it is actually the aversion of the calamity because it brings clarity to all the players and they can start dealing with the new price.
The alternative, to "prevent the crisis" involves regulation which inherently makes prices more opaque and makes it harder for the operators to know what things are really worth.
I am not presuming perfectly efficient markets, they can over react, but it is the ability for prices to move freely based on new information that is the mechanism by which things get worked out.
Seizing control over the market inevitably does more damage, because it prevents transparency about real prices.
It also creates moral hazard because it incentivizes bad activity-- you just have to be "too big to fail" and then your actions have no consequences, or perceived consequences.
The mental image I think people have is that the economy is an engine and it can sieze up if there's not enough liduidity like oil, in it.
But that's not really right. If allowed, it will react fairly quickly and seek the least painful solution to the problem by letting actors price based on how efficiently they can solve the problem.
It is important for institutions that act poorly to fail, so that the following institutions can learn from their mistakes, or institute controls to reign in their excesses.
It is all the external solutions, like TARP and Stimulus, that are the sand in the oil, so to speak.
I've broadened my response, more to make my core point, and realize you may not be disagreeing with me.
BTW, the FDIC increases bank failures by having a government monopoly on deposit insurance. The rates are not priced actuarially and thus bad banks are not incentivized to be good banks less likely to fail. This is an example of the moral hazard. (not to mention the inherent risk of fractional reserve banking in the first place.)