U.S. bailout is bitter pill for free marketeers

NEW YORK/CHICAGO (Reuters) - The government, like a knight in shining armor, rides to the rescue in a financial crisis by pledging vast amounts of taxpayers money in what has been dubbed: "The bailout to end all bailouts."

No, this isn't Thailand, Indonesia or even Italy. It's the United States, and some people are wondering if this week's dramatic events on Wall Street and in Washington spell the end of U.S.-style free market capitalism.

"It's a bitter pill for all those to claim that unfettered free markets were the best, that we don't need regulation," said Dan Seiver, finance professor at San Diego State University. "But perhaps this idea that unfettered capitalism is the way to go has finally been put to rest."

The U.S. government put curbs on short-selling and offered guarantees to money-market mutual funds on Friday as it worked on a sweeping bailout to mop up hundreds of billions of dollars in poisonous mortgage debt. That followed government bailouts of three financial giants already this month.

Stocks soared in response, led by financials.

"While Wall Street celebrates, the man in the street should be crying in his beer," said Seiver. "It's socialism for the rich, capitalism for the poor."

So far, the government has thrown well over $1 trillion at the credit crisis.

Jeffrey Frankel, an economist at Harvard's Kennedy School of Government, said the latest steps were necessary, but would impact everything from the deficit to inflation.

"These are people who, a short time ago, would have said they would never do such a thing, and mostly they meant it," Frankel said. "It had to be done. The question is to what extent it marks a shift towards more intervention."

He said there would be pressure for more regulation as a trade-off for government bailouts, but said history indicated policy makers tend to demand deregulation in good times then "bail out like crazy" when a crisis hits.

"It's millennia that people have been not fixing the roof when the sun is shining, and then when it rains saying 'I really should have fixed that hole,'" he said.

MORASS OF REGULATION

Sharyn O'Halloran, professor of political science at Columbia University, said the government action addressed the short-term liquidity crisis as well as the medium term problem of dealing with bad assets.

"On the longer term regulatory structure issue, there's no strategic thought or plan in place, and that's really what's problematic," O'Halloran said.

She said the current U.S. system was "a morass of regulation" that needs reform, not just more regulation.

Raghuram Rajan, finance professor at University of Chicago's Graduate School of Business and former chief economist with the International Monetary Fund, said the government had rushed to spend public money without trying all the private sector solutions.

"In times of crisis, broad principles tend to be forgotten," he said, adding: "Given how close we are to the election, there is a tremendous amount of political pressure to do something, to not appear as passive, and that to me is potentially distortionary."

Kenneth Rogoff, professor of economics at Harvard, said the crisis did not indicate the United States was abandoning the free market but raised questions about where Wall Street will be in ten years time.

"The U.S. financial sector is a flagship sector of our economy," he said. "It's an area where we dominate, and it's allowed us to live beyond our means for a long time."

He said a deep recession was now inevitable and the collapse of the financial sector could lead Asian and other international investors to rethink where they put their money.

Frankel said he would have expected to see a shift towards euro-denominated assets.

"If you think of the longer term implications, the deficit, the national debt, the money supply, and therefore inflation and just the prestige of U.S. financial markets, you would certainly think we'd see some shifts out of dollars," he said.

The U.S. actions will radiate out in the global economy, Rogoff said. "Europe might be forced to do similar measures."

The U.S. government will also be under pressure for more bailouts. "I think they're going to have to intervene in other sectors, like auto loans, student loans. Now they've caved on this, it's going to make it tough not to in other areas."

(Editing by Leslie Gevirtz)