Is it too big to fail? Megan McArdle believes the possibility certainly exists (I mean was Arnie really in DC yesterday just to see the sights). Says McArdle:

If the government does bail out the muni bond market, how should it go about things? The initial assumption is that they’ll only guarantee existing debt. Otherwise, it would be like handing the keys to the treasury to every mayor, county board, and state legislature, and telling them to go to town.

But once the treasury has bailed out a single state, there will be a strongly implied guarantee on all such debt. So you don’t give them the keys to the vaults, but you do leave a window open, point out where the money’s kept, and casually mention that you’ve given the armed guards the week off.

Of course the right answer is not to bail out either. Failure is a great teacher. And then there’s the moral hazzard angle.

But in this day and age, that’s approach is almost unthinkable apparently. Government, as we’re being told, is the answer to everything.

My fear, based on what the federal government has done to this point, is they’ll “hand the keys to the treasury” on both the muni bond market and the states (with bailouts). They have no business doing anything in either place, but we’ve already seen that the arbitrary assessment that some entity is too big to fail apparently takes priority over economic law.

Once a single state is bailed out, there is nothing to stop other states from making a similar claim on the treasury.

Should such a thing happen in either case (or both), Federalism, which is on its last legs anyway, will be officially dead.

[Crossposted at QandO]

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