An Ocean of Bail-Outs (2008 Nov)

by Barry A. Liebling

The last few months of 2008 have been characterized by a barrage of economic crises. Because the federal government encouraged the creation of mountains of mortgage-backed securities that turned out to be lousy investments, prominent financial institutions on the brink of ruin have gone out of business, or have been swallowed by their competitors, or have converted themselves from investment banks to commercial banks. A stupendously expensive bail-out package for financial service companies has been approved by Congress that is designed to “rescue the economic system.”

Members of Congress were quick to see that the bail-out would be unpalatable to a large segment of their constituencies. If the government can rescue the fat cats on Wall Street why not also help ordinary citizens who are having trouble paying off their mortgages and may lose their homes? Surely if companies that made poor decisions can obtain government help so should common people who were similarly lacking in prudence.

Note well – the issue can be resolved from two diametric perspectives. Supporters of free markets might say, “Exactly! No one should be bailed-out by the government. Let both companies and individuals who behave foolishly find private solutions to their self-caused problems.” But interventionists see tantalizing opportunities and may exclaim, “Everyone who has needs should be considered for government assistance. Let’s grow the government to make it happen.”

Conservative pundits were quick to notice that bailing-out people who are behind in their mortgage payments introduces new problems of fairness. What about responsible people who have been conscientious about their mortgages? Are they justified in feeling resentful if their reckless neighbors get a free ride from the government? Supporters of bailing-out delinquent consumers reply “no” and assert that helping those who are behind benefits everyone – since if a property “is allowed to go into foreclosure” it lowers the value of the properties around it.

The financial services sector is not the end of the story. The largest automobile manufactures are gesturing with outstretched hands for guaranteed government loans to “assure their survival.” Certainly if a case can be made for financial services companies and customers, a similar argument can apply for car companies. And the rhetorical process can be repeated for every industry and for every type of predicament a consumer can get himself into.

Of course, government bail-outs are nothing new. The history of the United States is littered with instances of the heavy visible hand mucking around and taking actions that would never have been done by free individuals acting on their own. What has changed is that the magnitude, frequency, and social acceptability of bail-outs is accelerating. And this will change the way business is done.

In an environment where the government assumes its proper role – to prevent the use of force and fraud – companies operate in a free market. Long-term success means creating products and services that other businesses and consumers are willing to buy at a price that is profitable to the company. Executives know that if their business model or their execution does not work their company may cease to exist.

But as the government devolves into an agent with the power to rescue, to reward, and to punish business establishments, companies are floating in a political ocean. This changes the game. While pleasing customers will still have its place, currying the favor of government officials will be the connivers’ path to success. Business executives will know that they can reap profits if they plead with the government that they have needs, if they can direct their companies toward activities that are favored by the party in power, if they can convince the public at large that if their companies were to fail harm would come to others.

This last point is worth considering. In the current economic crisis the bail-out of financial services companies was justified by the threat that if the government did not intervene the consequences would be catastrophic. In the future business planners will know that the government might save their companies if failure leads to widespread misery. This will motivate some to deliberately entangle their companies in relationships where if one company sinks many will join it. Think of it as an insurance policy to share failure.

Of course, government officials will catch on to the ploy immediately. And this will give them ammunition to enact a myriad of regulations and to micro manage entire industries. Since we – the government – are committed to helping out companies in trouble, we demand that companies not take any unnecessary risks, we demand that business managers get our approval before embarking in new directions. Imagine what effect this will have on innovation. The track record of government-planned economies is well-documented and consistent.

And even as the helping hand of government will restrain businesses from getting into too much trouble, it will act similarly to make sure that consumers refrain from acting foolishly. Zealots will be eager to create government-enforced rules that will tell you how large of a mortgage you are permitted to seek, how much you can charge on your credit card, what sorts of purchases you should or should not make. After all, if we – the government – agree to bail you out, you are obligated to comply with our directives.

The bottom line is that the trend in government bail-outs will shift the landscape. There will still be ethical executives attempting to do business properly, but the environment will give license to mendicants who will scheme on how to feed from the public trough. The government will still protect individual rights sometimes, but – moving in the opposite direction – it will dole out prizes and administer punishments in support of the politically connected. There will still be free market advocates who understand the pernicious nature of public bail-outs, but they will need to explain their case more convincingly.

*** See other entries at in “Monthly Columns.” ***

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