When Walter Bagehot, the Victorian economist, wanted to explain how central banks should act as lenders of last resort, he quoted a director of the Bank of England. “We lent it by every possible means and in modes we had never adopted before,” the central banker said of the BoE’s response to a financial panic.
The US Federal Reserve’s decision to include junk bonds in its latest asset purchase schemes reflects this century-old principle that when the financial sector is in trouble it is often better to hose it with cash than be too discriminating about the effects. Buying junk bonds will mean tacitly supporting some of the private equity companies that have specialised in capital engineering and loading companies up with debt.
For many this violates the fundamental basis of capitalism: badly-run businesses should go bust and speculators should expect to lose their money if bets turn bad. That includes those who did not prepare adequately for a crisis whether through overly leveraging their assets or making their companies fragile through stock buybacks. If shareholders enjoy the rewards of being less risk-averse than others so, too, should they carry the costs. Workers, many Americans point out, have been encouraged to put aside enough of their pay to cover for unforeseen circumstances; so should businesses.