Too big to fail

I keep hearing this statement tossed around when talking about particular businesses or industries. That latest chatter is that surrounding Fannie Mae and Freddie Mac, the mortgage giants who are in deep financial doo-doo over lots and lots of bad debt on their books. Nothing is too big to fail. If Fannie and Freddie are bailed out by the U.S. Government (you and I paying the bill) then we are creating a serious moral hazard. Why should corporations or individuals take any financial responsibility for themselves if they know the government will bail them out when they leveraged beyond their ability to pay?

In 1989 the Savings and Loans were bailed out by the US government for $124 billion. Nine years later, LTCM (Long Term Capital Managment) was bailed out by a mix of investors and the government for mere pocket change, only $3.6 billion. Of course, then there was the Bear Stearns bailout (a credit line issued by JPMorgan with a guarantee by the federal government) ever so recently.

Companies don't learn to take care of their financials, because they don't have to. Regular bailouts ensure that large corporations need not worry too much about solvency, because they implicitly backed by the federal government. The government won't necessarily raise our taxes to pay the bill; they can always print more money. Of course, this leads to inflation which means that we need more money to maintain the same lifestyle. I think we need to let a lot of businesses fail in order to maintain a strong free market. When businesses fail, it keeps business honest. If these bailouts continue, I predict the next big one will be in year 2020.

Update: Here