I think it’s a mistake to bail out profligate governments, and I have the same skeptical attitude about bailouts for mismanaged banks and inefficient car companies.
Simply stated, bailouts reward past bad behavior and make future bad behavior more likely (what economists call moral hazard).
But some folks think government was right to put taxpayers on the hook for the sloppy decisions of private companies. Here’s the key passage in USA Today’s editorial on bailouts.
Put simply, the bailouts worked. True, in some cases the government did not do a very good job with the details, and taxpayers are out $142 billion in connection with the non-TARP takeovers of housing giants Fannie Mae and Freddie Mac. But it’s time for the economic purists and the Washington cynics to admit that government can occasionally do something positive, at least when faced with a terrifying crisis.
Well, I guess I’m one of those “economic purists” and “Washington cynics,” so I’m still holding firm to the position that the bailouts were a mistake. In my “opposing view” column, I argue that the auto bailout sets a very bad precedent.
Unfortunately, the bailout craze in the United States is a worrisome sign cronyism is taking root. In the GM/Chrysler bailout, Washington intervened in the bankruptcy process and arbitrarily tilted the playing field to help politically powerful creditors at the expense of others. …This precedent makes it more difficult to feel confident that the rule of law will be respected in the future when companies get in trouble. It also means investors will be less willing to put money into weak firms. That’s not good for workers, and not good for the economy.
If I had more space (the limit was about 350 words), I also would have dismissed the silly assertion that the auto bailout was a success. Yes, GM and Chrysler are still in business, but the worst business in the world can be kept alive with sufficiently large transfusions of taxpayer funds.
And we’re not talking small amounts. The direct cost to taxpayers presently is about $25 billion, though I noted as a postscript in this otherwise humorous post that experts like John Ransom have shown the total cost is far higher.
And here’s what I wrote about the financial sector bailouts.
The pro-bailout crowd argues that lawmakers had no choice. We had to recapitalize the financial system, they argued, to avoid another Great Depression. This is nonsense. The federal government could have used what’s known as “FDIC resolution” to take over insolvent institutions while protecting retail customers. Yes, taxpayer money still would have been involved, but shareholders, bondholders and top executives would have taken bigger losses. These relatively rich groups of people are precisely the ones who should burn their fingers when they touch hot stoves. Capitalism without bankruptcy, after all, is like religion without hell. And that’s what we got with TARP. Private profits and socialized losses are no way to operate a prosperous economy.
The part about “FDIC resolution” is critical. I’ve explained, both in a post criticizing Dick Cheney and in another post praising Paul Volcker, that policymakers didn’t face a choice of TARP vs nothing. They could have chosen the quick and simple option of giving the Federal Deposit Insurance Corporation additional authority to put insolvent banks into something akin to receivership.
Indeed, I explained in an online debate for U.S. News & World Report that the FDIC did handle the bankruptcies of both IndyMac and WaMu. And they could have used the same process for every other poorly run financial institution.
But the politicians didn’t want that approach because their rich contributors would have lost money.
I have nothing against rich people, of course, but I want them to earn money honestly.
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The auto bailout cannot even be defended as representing systemic risk.
But in general,
Of course government can get some things right. By virtue of the law of probabilities, sometimes the government action will turn out even near optimal or better than the private sector. But these instances are rare, not only because of government actions being influenced by chronyism but also because monolithic mandatory plans are too inflexible to be optimal, often. But most importantly, those rare instances where government action was near optimal are only known retrospectively, after the fact. Unfortunately, prevailing voter temptation is the to have majorities exert collective management on the economy, under the authority given to A FEW expert bureaucrats, rather than letting ALL private actors compete towards higher efficiency solutions. Yes, there are instances where the expert committees get it right, but, again, success is only known after the fact. In general, competition between private actors has a higher success ratio in arriving at better solutions. And if that means the difference between a two percent growth rate trendline and a four percent one, then the prosperity difference becomes enormous because of compounding.
But “one more last intervention to just fix a few problems and then we can go back to free markets.. ” say the prevailing voter majority.
So the biggest condemnation of the bailouts, is the very trajectory of interventions and distortions that made the bailouts necessary/appealing (pick your word) in the first place. So we got to the bailouts primarily because of past collective economic management interventions which inflated the housing bubble and banking moral hazard into systemic threats.
So because collective management of the economy disliked the fact that many people overestimated the speed of the Internet revolution and bid .com companies to values which were (in retrospect, of course) well above fundamentals, and did not like the corrective stock market crash of the early 2000s, we collectively instituted (by FED, but really by collective majoritarian management of the economy) artificially low interest rates for a protracted period of time starting in the early 2000s. Then, also through collective management of the economy, in the name of environmentalism and city planning, we decided to encourage building of dwellings people did not want to live in (appartments or single family homes in far away exurbs, away from regulation, city planning and the usual pitchforks that show up at city hall every time something is to be built which yell: “we have found our paradise, now let’s close the door by preventing those landowners that did not build on their land houses like ours, from ever developing their own land”). So, of course, that created a shortage of those dwellings people DID want to live in and that contributed, in part, to prices soaring. So we had to take further collective economic management action to help people buy (bid against each other) the house they did do want to live in. So we gave people subsidies to mitigate the scarcity we had created for the good of the planet ( not really, just to prevent newcomers from moving into our neighborhoods). At the same time, in past collective economic management interventions, we had told bankers and depositors, through FDIC, that operating on the risky edge of the investment continuoum was an indirectly subsidized and profitable practice. Because big gains were kept by bankers and shareholders while there was a backstop for the equivalent losses. All that prevented many corrections that would have happened much earlier were it not for our delusional hope on shortcuts to prosperity through collective management of the economy, and so we got the bubble. Now, we are intervening with an even heavier hand and tell people who object: “if you can’t come up with the exact scenario this is going to lead to more bigger failures then shut up”. Of course, I cannot come up with the exact scenario (though some stronger possibilities stick out). That is the power of many market actors thinking independently AND being able to start taking corrective actions in undistorted markets as opposed to collective management of the economy through mandatory interventionist majoritarian rule. Majorities are, almost by definition… average, and so are their actions. How many breakthroughs have been invented by majorities? If the ability of more exceptional minds is hampered by distorting collective mandatory solutions, growth slows and decline mathematically follows. While many routinely deride the infamous “design by committee” in business, somehow economy design by the biggest commeetee, the national majority, prevails.
If we continue down this path of collective mandatory economic intervention and management, systemic risks will keep increasing in frequency and
magnitude – until economic inefficiency makes America just an ordinary country in terms of obstacles to entrepreneurship, at which point it won’t matter that much, because America will be fast fading into marginalization, something that is already happening and is poised to accelerate under the current prevailing urge to collectively manage the economy. Americans seem oblivious to how many cultures before them followed the same sirens of mandatory collectivism to their demise. But by virtue of the law of probabilities, seems impossible that Americans will refrain from making same mistake.
“Capitalism without bankruptcy, after all, is like religion without hell.”
Excellent comparison!