Scale, Scope, and What to do with Failing Banks (or: Has Cowen Forgotten his Higgs?)

Steven Horwitz

Tyler Cowen has responded to Pete over at Marginal Revolution.  Tyler seems to be arguing that the preferred way, for many libertarians, of dealing with failing banks is no better and probably worse than what actually happened, namely TARP and the other bailouts.  The preferred way for many of us was to let those banks go through the normal bankruptcy and reorganization process.  Tyler argues that this too is "government intervention" and that it is "ill-suited" to dealing with the sorts of problems we saw last fall.  He offers no argument for the claim of "ill-suitedness."

One commenter rightly notes that in the world of the second best, he'd prefer the known, predictable process of bankruptcy over the new, uncertain processes of the bailout.  I think that's exactly right.  One can make a Higgsian point here about regime uncertainty:  we're always better off (in the world of the second best) by operating under the known and predictable set of government rules than adopting new ones that have never been used before, or giving purely discretionary power to government agencies. 

But there's more to it than that.  We also know from Higgs and public choice theory more generally that once powers are given to government during a crisis, they never totally disappear when the crisis is over.  So even if one thinks there was something unique about the situation last fall, it's naive to think that the powers the Fed and other agencies grabbed to fight it would go away in the long run.  From a libertarian perspective then, the bailouts look like a really bad idea in the longer view.

Now Tyler and others might respond with:  "but wait a second, if you did all of this through the bankruptcy courts, wouldn't that be enlarging government's size as well?"  Yes it would but with one HUGE difference.  Giving more cases to bankruptcy courts would be an increase in the scale of government, but not in its scope. This scale vs. scope distinction is one Higgs makes at the beginning of Crisis and Leviathan but is often overlooked in quick discussions of its main arguments. 

Higgs refers to "scale" as government growing not by adding new powers but by having to do more with its existing powers due to things like growth in the population or the economy or in other factors that would draw more heavily on existing processes.  "Scope," by contrast, refers to the set of powers governments have.  Growth in scope means acquiring new powers.  In Higgs's theory of crises and government growth, the key point is that crises lead to expansions of the scope of government that do not ever completely disappear.

Returning to last fall:  the bailouts gave government new powers it never had before, expanding its scope, but using the bankruptcy process would have only expanded the scale of powers it already had.  Forced to make that choice, a libertarian perspective would see increasing the scale as the notably lesser of two evils.

It was inevitable that the state would be involved in resolving the banking situation one way or the other, but in that second best world it is much better to choose a known and predictable process that only expands government's scale over one that expands its scope by giving it powers it previously did not have.  From a libertarian perspective neither is ideal, but I would argue growth in scale is much less damaging than growth in scope, in the short run and especially the long run. 

I think Tyler's response completely overlooks these Higgsian points.

Comments

[vimothy]

Yes, but the libertarian way was tried with the failure of LEH - Barney Frank amusingly called this "free market day", and noted that the American commitment to free markets lasted precisely one day (bailout of AIG followed the day after).

Lehman's failure caused chaos in the credit markets, particularly the repo markets (per Gorton's excellent paper), leading to (effectively) runs on the shadow banking system. I mean, this was unpleasant, right? It seems to me that if you think that the existence of the Fed is a good thing, in principle intervening in the wholesale markets to prevent collapse is no different.