On Last Week’s Bailout (and Our Future Headache)

I was thinking of a story I heard years ago which has significant relevance to today’s economic climate.

In an undergraduate economics class, a professor held up a one dollar bill.  “I will give you this bill,” he said, “To the highest bidder.  The bidding begins at 1 penny.”  In true auction style, the bidding began.  Five cents, ten cents, 25 cents.  Up and up the price went until it got to over $1.  A matter of pride, the two bidders competed for this $1 bill.  One ended up paying nearly $2 for the bill!

Of course, the person who paid $1.80 or such for a one dollar bill loses 80 cents in the transaction.  Suppose he thought this was unfair.  “I paid $1.80,” he may reason.  “Perhaps that was too high, but $1.00 is certainly too low.  $1.40 is a much more reasonable price.”

But nearly no one would pay over one dollar for a one dollar bill.  How can he recoup his losses?  Suppose he forces someone to pay him $1.40 for the bill.  Sound ridiculous?  This is roughly what is happening with the bailout package passed last week.

The prices of assets, like real estate, shot up quickly, due to a misallocation of resources (artificially low interest rates set by the Fed).  These prices were unsustainable, and therefore, the peak price was not the true value of the asset.  The true value of the asset is much lower.

The bailout assigns the job of “price-fixing” to the treasury department.  The Secretary of the Treasury (or unelected bureaucrats working with him) decides which bad assets to purchase at inflated prices.  In effect, he is using taxpayer dollars (or inflationary spending) to buy one dollar bills for $1.40.  He actually decides which price is fair to purchase them at.  It’s true that the taxpayers may make some money on the venture (even a wrinkled dollar bill could be exchanged for another dollar bill), but on the aggregate, it is a loss.

To me, the greatest problem is the power we are investing the Treasury Department with.  One central planner (granted, there is allegedly some congressional oversight in this scheme) has been given a huge amount of unprecedented power to purchase overvalued assets at overvalued prices.  The taxpayer takes the loss.  The philosophical, moral, and ethical assumptions are staggering, not to mention the disturbing precedent set.

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Filed under Austrian Economics, fiscal policy, Libertarian, politics, role of government

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