The Slippery Slope of Government Bailouts

Stephen Bainbridge has done the best job I’ve seen of describing why bailing out the U.S. automobile industry — as proposed by Congressional Democratic leaders — would be a terrible mistake. Point by point he shows why the public interest would be better served by letting the big automakers go bankrupt, because bankruptcy reorganization would give them the leverage they need to modify ruinous contracts with unions and dealers.

Using GM as an example, he summarizes:

Letting GM avoid bankruptcy by giving it a federal bailout ought to be unthinkable, because of the very real risk that a federal bailout will come with conditions that preclude GM from fixing its core problems. It’s likely to preserve the gold plated union contracts, the excess payroll numbers, the excess plant capacity, and the excess number of dealers.

This helps illustrate why it was conservative Republicans, rather than Democrats, who led the initial opposition to the Wall Street rescue plan, and succeeded in voting down the first proposal. Stereotypes would lead a person to believe that Republicans would be more sympathetic to Wall Street than Democrats. But the conservatives were not opposing Wall Street — they were opposing creeping socialism. They knew that other troubled industries would soon be jockeying for position at the government trough.

If belief in capitalism and free markets means anything, it means the markets must be able to reallocate capital to more productive uses. It means reckless or uncompetitive companies have to be allowed to fail. Viewed through this filter, any financial calamity caused by allowing the giant Wall Street firms to fail could be considered a necessary side effect of adhering to capitalist principles.

I’m an ardent capitalist, but I quickly became persuaded that a Wall Street bailout was a necessary evil. (I’m sure Hank Paulson would have been relieved to learn that I was on board.) The financial services industry is a special case, because the flow of capital affects virtually every business, government and individual in the world.

The credit markets effectively were frozen, and 15 years as a Wall Street gumby has helped me understand what a potentially devastating problem that is. The short-term credit markets are like oxygen for banks and big companies. They have to be able to breathe capital in and out on a daily basis to meet their daily needs. It was only a matter of time — and not very much time — before even healthy blue-chip companies would be unable to issue paychecks on schedule, to pick just one example of the potential for panic.

The analogy that comes to mind for the Wall Street bailout is, let’s say your child misbehaves and you tell her she’s grounded for a week. On principal, you should not then allow her to go see a movie two days later, no matter how much she pleads. However, if the house catches fire, you need to set principle aside and let her escape.

The automakers are a completely different story. Bankruptcy reorganization would be a severe financial blow to huge numbers of individuals and communities — but it would not bring the entire economy to a halt.

4 thoughts on “The Slippery Slope of Government Bailouts

  1. Speaking as a liberal here I have to agree. :)) What’s upsetting in this entire situation is how there are so many attempts to plug the leaks in the dam, but no attempts to discover the sources of the leaks. And I would be opposed to any situation in which the government dictates how businesses can be run.

    I agree a bailout of GM is just sending good money after bad. But I do see the reasons behind it, as I’m sure we all do. I remember the recession back in the early 80s – the situation was bad, but the situation that’s unfolding around us now is much, much worse.

    It’s the shakeout, they say. While I think a shakeout is necessary and a good self-correcting measure, I wonder how our society will rebound should our major manufacturers fail and we become a completely consumer-driven economy? We’ve already moved our manufacturing offshore – if we make nothing here, where is our money going to come from?

    I admit I’m a complete financial dork. I’m not for the GM bailout, but I can’t see how we can avoid it.

  2. Hi Lori! Thanks for stopping by — as a blogger yourself, I know you know how gratifying it is to get comments.

    I don’t think there’s any danger that we will “make nothing here.” The major Japanese carmakers all have plants in the U.S. now, despite the cost advantages of operating in other countries. I expect they would continue to operate here even if GM shrinks dramatically.

    I think the Wall Street bailout was necessary to rescue the entire economy. I don’t think the government should be bailing out companies or industries when the sole or primary reason is to save jobs. And I acknowledge that I probably would feel differently if it were my family or my community that would be devastated by contraction of the auto business.

  3. Pingback: Slouching Towards Europe: Obama’s Domestic Agenda Undercuts American Exceptionalism :All That Is Necessary…

  4. Pingback: Slow Down on the Stimulus, and Stop Saying “Depression” | All That Is Necessary…

Leave a Reply

Your email address will not be published. Required fields are marked *