John Butler | Financial Sense
December 6 2011

For those awakening to the unpleasant reality that the global financial crisis which began in 2008 has never been resolved, we have some important news for you: There are, in fact, two crises unfolding in parallel. One is phoney and in the spotlight; the other is real yet lurks in the shadows. This is because the phoney crisis is the one that policymakers want you to see: the apparently insolvent banking system in need of a bailout. The real crisis they refuse even to talk about is that economic resources have been so massively misallocated in recent years that sustainable economic growth has become impossible. What is needed to solve the real crisis is not to bail out insolvent financial institutions, rather the opposite. It is through a general bankruptcy and restructuring of the financial systemthat economic resources can be properly reallocated to where they can be gainfully and efficiently employed, enabling a resumption of healthy, sustainable economic growth, to the benefit of all.

A Tale of Two Crises

The powers that be would have you believe that, had they not taken various arbitrary, extraordinary actions in 2008 and 2009, the global financial system would have imploded, tanking the economy and quite possibly threatening society and civilisation as we know it. QE1, QE2, TARP, TALF, the Fannie/Freddie nationalisation, etc, etc, were all therefore necessary, notwithstanding their dubious constitutionality.

We disagree. There is a fundamental principle of western civilisation, known as the rule of law, which could have been invoked instead. Contracts would have been honoured. Failing financial institutions would have been left to declare bankruptcy, their assets would have been seized by creditors and/or disposed of by administrators and eventually the financial system would have reformed into a deleveraged shadow of its former self.

But wouldn’t this have put depositors at risk? Isn’t that what they said when they were trying to get Congress to pass TARP? That depositors would be summarily wiped out and, in the ensuing economic chaos and social unrest, martial law would be invoked to restore order?

That is a complete, utter fabrication. There is no reason to believe that, had TARP not passed, there would have been a general breakdown in the economy and society generally. Yes, there would most certainly have been a great deal of disorder in financial markets. There would also, most probably, have been a severe recession, quite possibly worse than that experienced to date. But unlike the current situation, in which ‘too-big-to-fail’ financial institutions have continued to grow, threatening another crisis in the near-future, had these institutions been allowed to fail instead, they would no longer pose a systemic risk. Indeed, the financial sector would have shrunk and de-leveraged to a size more compatible with stable, sustainable economic growth.

What follows in the next section is what would happen were governments and central banks now to sit back and allow the rule of law, capitalism, free markets and Schumpeterian creative destruction to work their magic and solve the real crisis.

The Best of Times, The Worst of Times

This is not going to make for light reading. Arguably the most wonderful, magical thing that humans ever get to experience is the birth of a baby, the miracle of life. But boy, is it painful: in the moment for the mother and in the years of toil thereafter for the parents to earn an income, maintain a home and raise the child to adulthood.

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