A pragmatic libertarian defense of the bank bailouts

Tyler Cowen is defending the bank bailouts in America: 25 Aug, 27 Aug, 28 Aug.  I generally like what he says.  I want to highlight the third post in particular:

General pro-market or anti-government arguments don’t rule out the recent bailouts.  Let’s take the hardest, least Friedman-friendly case, the insolvent banks.  For insolvent banks (and for some of the illiquid banks, which might have failed without bailouts), the alternative to those bailouts is calling in deposit insurance and the bankruptcy courts, both of which are, for better or worse, forms of government intervention.  In particular today’s bankruptcy procedures are ill-suited for disposing of a large financial institution in a timely manner and this can be considered a form of gross government failure.

Note that even when the Fed “bails out” a large investment bank, or insurance company, they are checking a chain reaction which would likely spread to some commercial banks, thus bringing in deposit insurance as well, not to mention further bankruptcies.  And that’s not even considering that Congress probably would have stepped in, I’m just looking at laws already on the books.

So if you’re “opposed to financial bailouts,” as a libertarian, you’re not for the market.  You’re saying that one scheme for governmental disposition is better than another.  Of course you are entitled to that opinion but the sheer force of libertarian doctrine is not necessarily on your side.  The general pro-market and anti-government arguments are not necessarily on your side.  I think it is quite plausible for a libertarian to believe that the Fed is “less bad” than the bankruptcy courts and the FDIC.

Now, all things considered, I don’t see why this “libertarian two-step” move should be needed.  I think it’s enough to simply ask whether the bailouts were a good idea and proceed accordingly.  But if you’re concerned about compatibility with libertarian principle, this is one simple way of seeing why my view fits right in.  In fact I think it is the more libertarian of the views under consideration, as it keeps the very worst of the government interventions on the table at bay.

No doubt some libertarians will counter that the FDIC and bankruptcy courts ought not to exist either (I disagree with that – while neither is perfect, they’re both needed.  But then, I’m hardly a libertarian), but that misses the point of Tyler’s title for the post:  “A second-best theory of libertarian bailouts”.  The world of second-best is the real world.  It accepts that things are currently as they are and asks what is best given the current state of the world, not in all possible worlds.