The case for doing nothing: the only plausible argument for bailing out banks crumbles on close examination.

• Author: Miron, Jeffrey
• Position: Viewpoint essay

THE FIRST THING to note about the financial crisis is that the federal government never had any business intervening in the personal decision of whether you want to own a home. There is no rational economic argument, or any argument I know of, that says the market of buying and selling homes is imperfect in some way, requiring government action. Construction firms have plenty of incentive to build homes and sell them. People who have the wherewithal have plenty of incentive to buy homes if they so choose. For the government to intrude into homeownership was an off-budget, nontransparent, backdoor attempt at redistributing income. And when the policy became a way of transferring income to people who couldn't afford those homes, it was doomed to failure.

This provision of risky debt to low-income homeowners was exacerbated by a second misguided federal policy: the longstanding practice of bailing out private risk taking. Although this has gone on for decades in the U.S. and other countries, the Federal Reserve played a special role during the tenure of former chief Alan Greenspan. The Fed's implicit and almost explicit policy before the housing crash was to say to the financial markets: "Don't worry about the fact that there's a bubble. We'll lower interest rates and keep them low enough to prevent a collapse in asset prices" This logic, broadly applied, was commonly called the Greenspan Put. The Federal Reserve was basically selling the market an option for getting out comparatively unscathed when things turned bad. The result has been a widely held assumption that market actors would not have to bear the full losses from their own risky behavior.

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When people try to pin the blame for the financial crisis on the introduction of derivatives, or the increase in securitization, or the failure of ratings agencies, it's important to remember that the magnitude of both boom and bust was increased exponentially because of the notion in the back of everyone's mind that if things went badly, the government would bail us out. And in fact, that is what the federal government has done. But before critiquing this series of interventions, perhaps we should ask what the alternative was. Lots of people talk as if there was no option other than bailing out financial institutions. But you always have a choice. You may not like the other choices, but you always have a choice. We could have, for example, done nothing.

Unfair in the Short Term, Inappropriate in the Long Term

By doing nothing, I mean we could have done nothing new. Existing policies were available, which means bankruptcy or, in the case of banks, Federal Deposit Insurance Corporation receivership. Some sort of orderly, temporary control of a failing institution for the purpose of either selling off the assets and...