Wesbury’s Monday Morning Outlook: Stress Test Government
Date: June 26, 2017
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The Federal Reserve just finished its annual round of large
bank stress tests. The banks all passed – meaning they had
enough capital to withstand a massive financial shock and deep
recession.
These stress tests are the political result of the government
blaming banks, and not Fannie and Freddie, for the 2008 Panic
and are designed to prevent another “market failure.” The idea
is that free markets have a tendency, all on their own, to lurch
into panics, recessions or depressions. But if the federal
government really wanted to develop stress tests to help
maintain prosperity, we think it’d do a lot more good to stress
test government, not the banks.
The biggest threat to prosperity has never been market
failure; instead, the biggest threat is “government failure.”
Markets didn’t fail in the Soviet Union, North Korea,
Puerto Rico, Detroit, or Illinois. Government failed.
There are three main types of government failure. One,
government policies, even if well-intentioned, often cause poor
investment decisions that either lead to the very panics and
depressions that some accuse free markets of causing or simply
lower the long-term growth potential of the economy.
Two, the tendency of government to kick the can down
the road for others to fix later. And, three, the fact that
the government, which claims to know how to keep private
companies from collapse, can’t stop government entities from
collapsing because they don’t operate like a business.
For example, right now the great state of Illinois has no
budget, has not run a balanced budget in more than 15 years,
and is technically bankrupt. Why has no one stopped this?
Where are the stress tests, regulations and “claw backs” to
punish those responsible for this financial mess? Government
employees in Illinois seem to think they have more claim to the
incomes and assets of the citizens of the state than the citizens
themselves. This is a disaster that could – and should – have
been avoided.
How can the Federal Government run deficits year after
year, and project deficits for decades into the future, yet keep
spending as if all was well? The US is in the midst of one of its
longest recoveries ever and government still couldn’t pass any
kind of reasonable stress test.
Government failure has always been, and will always be, a
bigger threat than market failure. A free people have a natural
incentive to fix incorrect consensus judgments in the market.
Are a company’s stock or bonds overvalued? Is a bank
overlending? If so, then markets work to correct them. The
market punishes bad business decisions. Even if you don’t
think markets always fix themselves, at least you have to admit
others have an incentive to do so.
Not so with mistakes by the government. If anything,
government policies are more prone to create “herding”
behavior because these policies are backed by government
sanctions, like fines, or even jail. Take rules that require banks
to lend for reasons other than the expected return on
investment, like the Community Reinvestment Act. Ignoring
this, if you think its bad business, could get you in big trouble.
We won’t hold our breath waiting for the government to
stress test itself, something many companies already do on their
own without any government prodding. The reason we won’t is
because we already know what an honest assessment would
say. The present course of government policy in many states –
and the federal government as a whole – is unsustainable.
Who’s going to stress test that?

Rogan & Associates

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