A big problem with the government intervention is that the institutions that acted prudently don’t get the reward they should. Most of the smaller banks in the country sat out the sub prime orgy and are in good shape. They stuck to what bankers have traditionally done; they took deposits and loaned them out prudently. In a world absent government intervention, they would take deposits from poorly managed banks and expand their market share. The government intervention is stopping that positive process (via WSJ):

WASHINGTON — The Treasury’s bailout plan is fueling a long-simmering war between financial institutions, prompting fears among small banks that big banks getting rescue money will be encouraged to buy smaller rivals.

Big banks say the purchase of smaller, ailing institutions by larger ones promotes the recovery of the sector. But representatives of some 8,000 community banks — the bulk of which remain financially sound — worry that a taxpayer-subsidized consolidation could sweep up healthy institutions that are too small to fight back.

The government should not be choosing winners and losers. The market is much better at sorting these things out than the government. Let the market work.

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