At the height of the financial crisis the US government dramatically bailed out the insurer AIG. Last week it sold its last remaining shares in AIG for a tidy profit. Surely this marks the end of a chapter and should be the cause of some seasonal good cheer. Actually, no, it is an unmitigated disaster – I shall explain why.

I do not agree with the US government’s decision to bail-out AIG but I do understand why they did it. If AIG had been allowed to fail it would not have been able to honour the large number of CDS and CDO contracts that it had written, which could have resulted in the failure of many financial institutions that stood on the other side of those contracts and might have even led to the failure of financial system as a whole.

The banks that would have taken losses had AIG been allowed to fail may have learnt from their mistakes and perhaps would have become more careful about taking these or other risks. Or they may have not – I don’t know. However, if AIG had failed, I would really have great confidence in the surviving banks’ ability to manage risk.

This is in fact the essence and strength of capitalism. In good times (almost) everyone makes money. However in a downturn, the strongest survive, whilst the weakest go bankrupt or are taken over or suffer losses and have to adapt. This means that the companies that emerge are stronger, or at least fitter to survive the new economic environment. Similarly the system as a whole gets stronger from the failure of the weakest elements. This process is not like an evolutionary process, it is an evolutionary process. And that is why capitalist systems are generally resilient and robust.

But when governments intervene they undermine this process – the individual circumstance of every bailout may be entirely justifiable and understandable, but the cumulative impact is to undermine the resilience of the system as a whole. We are familiar with the result: it is the zombie banks of Japan and Europe, the car companies of Britain in the 1970s and the big auto manufacturers of the US rust belt. All of these companies depend for their existence on government handouts. And, just like people who depend on handouts, they quickly evolve a dependency culture from which they can never escape. Worse, every time the financial system is bailed out, through direct intervention such as AIG or LTCM, through low interest rates, through quantitative easing, or from any other means, it too becomes less resilient and more likely to fail.

So next time a bailout situation arises, the government in question will look at AIG and think ‘well that worked out alright’ and will be a little less reluctant to take the plunge. We are well on the way down the road to zombiedom.

Nick Silver 154x154

IEA Pensions Fellow

Nick Silver is the Pensions Fellow at the Institute of Economic Affairs. Nick is also Director of Callund Consulting Limited, where he provides public policy advice on social security, pensions and consultancy services to corporate clients in all continents, in respect of non-state employee benefits. From 1998-2005, Nick was Director of Silver Actuarial Services. Prior to this, he was Manager of PricewaterhouseCoopers in the actuarial Department, and worked as an Actuary from 1991 to 1997. Nick received an MSc in Public Financial Policy (Merit) in 2004 from the London School of Economics and Political Science (LSE). He also has a BSc Hon in Mathematics from Bristol University. He is a Fellow of the Institute of Actuaries.

1 thought on “The road to zombiedom”

  1. Posted 20/12/2012 at 20:02 | Permalink

    Yeah, instead of creating a “zombie” the Government should have just nationalized the company and fired its management, plus openly prosecuted anyone it found guilty of outright fraud….

    Wait, that isn’t what IEA would have demanded? Color me shocked.

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