Are the Government's Bailouts Hurting the Economy?

Some say that Japan should have let its weakest banks fail.

"It is a matter of wise pruning," said Meir Statman, a finance professor at the University of Santa Clara in California. "You don't want to cut the trunk and you don't want to cut the main branches, but you do want to cut the weak and dead branches."

Supporters of the federal government's recent actions would argue that it did cut at least one weak branch when it declined to back a deal that would have kept Lehman Brothers, the country's fourth-largest brokerage firm, afloat.

Indeed, standing by and allowing Lehman to file for bankruptcy earned the federal government plaudits from some analysts and scholars, including Reinhart, who are concerned about moral hazard -- the idea that government bailouts will encourage businesses to make irresponsible decisions on the assumption that taxpayer money will serve as a cushion if things go awry.

Reinhart says he's now taking back his praise of the Feds.

"I would reverse myself on that view in the same way the secretary [Treasury Secretary Hank Paulson] reversed himself in his view of bailouts," he said.

Avoiding 'Maximum Pain'?

Statman, meanwhile, argues that if the government's bailouts delay the credit markets' hitting bottom, that might not be such a bad thing. It could, he said, avoid a wider panic.

"It's like administering a treatment that is painful," Statman said. "You can either do maximum pain for a short time or you can do smaller amounts of pain for a longer amount of time. It's not always the case that you want to get it over with with maximum pain."

If you choose the "maximum pain" option, he said, "the patient can go into shock."

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