“Capitalism without bankruptcy is like Christianity without hell.”
Over the past four decades, governments and central banks have developed and exercised a rescue reflex, bookended by the Continental Illinois National Bank and Trust Company and Silicon Valley Bank bailouts. Ironically, it was in 1984, during a period of shrinking federal government influence, when Continental Illinois became the first US bank viewed as too big to fail. In an unprecedented move at the time, regulators extended unlimited protection to Continental depositors — just as the Federal Deposit Insurance Corporation (FDIC) did in early March for Silicon Valley Bank and Signature Bank depositors.
Once Pandora’s Box had been opened, similar to the Greek myth, out crawled the Savings & Loan Crisis, Long Term Capital Management bailout, Global Financial Crisis, and the pandemic, among others. And today, it’s expected that governments and central banks will orchestrate rescues in response to crises. This century’s easy monetary policies combined with globalization’s greater connectivity magnified the rescue challenges. This required the Federal Reserve (Fed) and US Treasury to spend trillions of dollars on bailouts in 2008 and 2020.
However, despite still-sticky inflation and higher interest rates, the current banking crisis demonstrates that the easy money era might not be over. According to Strategas Research Partners, to avoid a systemic event in the first quarter, policymakers pumped $755 billion of liquidity into financial markets. Shockingly, the first quarterly increase since the third quarter of 2021 wiped out five months of quantitative tightening in just two weeks.1 This liquidity injection happened at the same time the Fed is fighting inflation. When push came to shove, liquidity won the quarter — and long-duration growth assets from NASDAQ companies to bitcoin topped the performance leaderboard.2
The current banking crisis reignited the bailout debate. Bailout apologists claim that rescues smooth out boom and bust economic cycles, restore confidence in the economy, reduce financial market volatility, and lower corporate default rates. Others argue that while rescues may relieve the short-term pain, they do little to solve longer-term problems.
All this begs the question — is capitalism really capitalism without failure?
The International Monetary Fund (IMF) identifies six pillars of capitalism, among them are competition and the limited role of government. The ability to separate the winners from the losers without too much interference from policymakers is critical to capitalism’s success. But governments regulate today’s markets to a greater extent to correct market failures.
Prior to the Continental Illinois bank failure, governments and central banks were reluctant to ride to the rescue. The pre-bailout era was characterized by volatile boom-bust economic cycles, strong productivity, and growing earnings power.
Addressing how today’s rescue culture undermines capitalism, Ruchir Sharma, Chair of Rockefeller International, writes, “The rescues have led to a massive misallocation of capital and a surge in the number of zombie firms, which contribute mightily to weakening business dynamism and productivity. In the US, total factor productivity growth fell to just 0.5% after 2008, down from about 2% between 1870 and the early 1970s.”3
Of course, nobody is pining for the harsh conditions that defined the Industrial Revolution or the bank runs of the 1930s. But the constant government rescues of the past few decades are a step too far in the wrong direction.
Well-intentioned government and central bank rescues may in fact be producing the opposite of their desired effect. Rather than stabilizing the financial system and bolstering the economy, bailouts could be contributing to sluggish growth and shaky markets. So much so that the failure of a single US regional bank threatened to infect the entire global banking industry.
This isn’t intended to be an indictment on policymakers’ actions in response to the recent Silicon Valley Bank, Signature Bank, and Credit Suisse failures. On the contrary, officials acted swiftly to restore much-needed confidence in the global banking system and likely prevented further contagion. This is the best possible outcome for the economy and markets.
However, today’s banking turmoil and policy responses provide investors a new lens through which to reflect on the impact of decades of bailouts. Policymakers’ proclivity to exercise the rescue reflex may deliver some short-term benefits. But investors know all too well that one of the enduring long-term lessons of a capitalist economy is that there’s no free lunch.
Weaker economic growth, lower productivity, and a decline in living standards might be too high a price to pay to be rescued.4 Perhaps, counterintuitively, bailouts haven’t made the global financial system more stable, but more fragile.
Possibly more disruptive, policymakers’ and investors’ senses may be getting increasingly dulled to the growing risks rescues pose to the global economy and financial markets.
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1 Strategas Research Partners, Policy Outlook, April 3, 2023.
2 Strategas Research Partners, Policy Outlook, April 3, 2023.
3 Ruchir Sharma, “The Unstoppable Rise of Government Rescues,” Financial Times, March 26, 2023.
4 Ruchir Sharma, “The Unstoppable Rise of Government Rescues,” Financial Times, March 26, 2023.
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