Again: Trim Taxpayers or Trim Investors?

Why do investors have a special claim on the public fisc? This time, I'll outsource the job of answering to an expert:

The unsatisfactory answer to that question that we often hear is some version of preventing damage to the broader economy.

It is worth unpacking that answer. When Institution X fails, the damage falls first on Institution X's equity holders and secondly on Institution X's creditors in reverse order of their seniority. I don't think any reasonable definition of the "broader economy" can include parties that have transacted with Institution X, whether in labor, capital, or product markets. They are in what I would call the "narrow economy of Institution X."

A distant third in the damage lineup to the failure of Institution X is the "broader economy," in which we might reasonably include taxpayers who no longer get to tax the profits of Institution X and potential customers of Institution X who no longer get the consumer surplus associated with transacting with Institution X. But of course it would be crazy for taxpayers to give Institution X money so that some fraction of that money could be paid back as taxes. And the notion that the potential customers of Institution X cannot be served nearly as well by Institution Y -- or the Federal government temporarily standing in for Institution Y -- is just as crazy.

There are some entities in the "narrow economy of Institution X" that have federal insurance protections: bank depositors via the FDIC and workers via the unemployment insurance system. Speaking on behalf of "the broader economy," I have no problems with paying on those insurance claims as needed when Institution X fails. But that's where I draw the line. Small damage to the broader economy is being used as an excuse to transfer large sums to various narrow economies. This practice should stop.