Morals and hazards: Pros and cons of the bailout
By Daniel M. Ryan
web posted September 29, 2008
Detours and Upsets
As of the time of my writing this piece, the announced $700 billion bailout of the American banking system is yet to be a done deal. Congress, as we all know, has balked at least twice. One of the interesting wrinkles in the bailout package's wobbly course is the ease in which the Administration bent to most of the Democrats' demands. When Treasury Secretary Paulson first proposed it, the fund was supposed to be a straight $700 billion put into the hands of the Treasury for buying up bank assets fallen on hard times. The modification of the original plan from a blanket authorize-and-disburse sign-off to a three-tranche deal came from Democrats' complaints about assigning that much taxpayer money to be deployed at Treasury discretion, which would have cut Congress out of the loop entirely. Now, as the Democrats demanded, only $250 billion will be available at discretion upon the package's passing. The next $100 billion will have to be asked for, by Secretary Paulson formally vouching that it's specially needed, and the final $350 billion will be subject to a veto vote. With the exception of a set-aside for low-income housing and bankruptcy-judge intercession on the behalf of mortgaged citizens now in distress, the Democrats have gotten their way. There's even Administration agreeableness about golden-parachute takebacks, and assignation of warrants in exchange for government help for rescued firms.
Now, it's the Republicans who have balked in a classic backbenchers' revolt. In addition, many Americans have also balked: although President Bush's Wednesday night speech got to the nub of the matter, from the mainstream standpoint, there's still a lot of street-level hostility to the plan. A good argument can be made that the downfall of Washington Mutual was a further concession, this time to the American public. The usual rule for financial crises is that one firm goes belly up, to send a message to the others to cool it, while the others get rescued. Until Washington Mutual's retail arm was sold to J.P. Morgan Chase at the FDIC's behest, this script was playing out in a normal manner. Lehman Brothers was sent to the "Q sheets" (into bankruptcy) and AIG was rescued with a loan guarantee, although at the price of signing over a lot of AIG warrants to the Treasury – enough for the U.S. government to claim about 80% of the common equity of the firm. Despite hints of socialism in this price tag, it's largely seen as a formality – a way to set a sliding price scale for the help, as based upon the extent of the recovery in AIG's common shares. As of Thursday, it looked as if Lehman would be the only one whose common equity was wiped out. Then came the WaMu dismemberment, which drove the already-beaten-down common shares down about 90% on Friday morning.
Assuming along with Barney Frank that the bailout will be agreed upon by Monday, I present a brief list of the pros and cons:
- The bailout will get the economy moving again. President Bush made precisely this point in his speech, and there's little need to elaborate further. The bailout will put an end to the current credit crunch turning into something more serious – like a monster recession.
- Although big financiers seem to be the pampered pets in the drama, they're needed too much; if they're not bailed out, credit flow will grind to a halt, which will hurt too many people as a side effect. This point addresses the oft-heard criticism of the bailout being little more than a shakedown using our fear of a Great Depression to make us suckers for the Manhattan-Greenwich-Hamptons circuit. Since the modern economy is held together by easy credit, punishing the big boys through letting liquidation rip would amount to playing a game of chicken with full intent to ram the rich fellow…regardless of the consequences to the rammer.
- $700 billion now will put a stop to it; the piecemeal approach will cost much more later. The total cost of the toxic-mortgage fallout has been estimated at more than $2 trillion, including the ARM-payment-adjustment problems coming along the way in '09 and '10. The breakup of Washington Mutual, which was brought down largely through making imprudent ARM loans, is an example of how government action can head off a tax-costly crisis at the pass. If one ARM-loan crisis can be solved at zero cost to the taxpayers, then others can (at least potentially) be solved at lessened cost if rescued right. Deploying the bailout package now should make for similar pre-emptive cost containment.
- J.P Morgan Chase's takeover of WaMu shows that a bailout will engender quid-pro-quos that will lessen the cost to the taxpayers. The notion that a bailout is some kind of God-given right, if it ever existed on Wall Street and Banker's Row, is fading as evinced by the co-operativeness shown by CEOs like J.P. Morgan's James Dimon. For all we know, the CEO of Washington Mutual showed the same co-operativeness in boarding up the shop before things got worse. The CEO of AIG may have too when agreeing to the warrant-issuance price tag for the two-year loan from the government. There seems to be a healthy somberness emerging in the financial-services sector, which belies the stereotype of financier pigs trotting up to the trough.
- The bailout being administered by a former Wall Street executive will assure that U.S. taxpayers won't get dinged that badly because his skills are working for the taxpayers now. This argument is the flip-side of the distinterestedness one. Although it is formally mistaken to confuse "disinterested" with "uninterested," it is also true that interested people pick up a lot of tricks and skills that disinterested people consider beneath them. A career bureaucrat may be as sober as a judge, but a prosecutor that's a former defense lawyer (or vice versa) is goal-driven in a way that the more sedate judge cannot be. A silver-tongued negotiator matched against a disinterested person will get the better of the latter ten times out of ten, unless a Black Swan somehow intrudes.
- The bailout will get the financial economy moving again, in the wrong direction. Despite the rule of "one failure only" being broken by the WaMu sale, the increasing taste for risk shown by Wall Street firms will likely continue to grow because it's evidently endemic. The last time that Wall Street categorically abjured risk was after the Great Depression, when many firms went under. More recent odds say that, after a cooling-off period, the risk-seeking will come right back as the envelope is pushed again towards the next plummet. History clearly suggests that the only "black swan" that'll change Wall Street's ways is a rampaging death-swan.
- The big financiers have been the pampered pets for too long, and the mainstream figures who say "depression…depression...depression" have been Chicken Little'ing for too long; Wall Street won't change its ways without a bloodbath, and it's time they finally got one. To continue with the chicken-game metaphor, this argument suggests that the rich fellow with his mainstream-academic passenger/supporter has been living on a bluff.
- This bailout is far from the first one these past ten years; those other rescues clearly suggest that there'll be yet another one come the ARM-adjustment crisis at the end of this decade. Long Term Capital in 1998; Y2K in 1999; the dot-com implosion in 2001 – when does it end? Plus, there is disturbing evidence that the last bailout fuels the next blowout, making the next ‘one-time' bailout a cyclical event. The last ten years gives us no assurance that the financial-services sector will not be cap-in-hand'ing come 2010; they've evidently become habituated to it. Betting on the absence of a Black Swan may be imprudent, but how imprudent is it to bet on a Black Swan – a spontaneous mending of financiers' ways – to show up?
- The Wall Street entitlement mentality has gone nowhere; they're only "co-operative" when the heat's on, and secretly nurse a "the government owes us big-time" mentality when they're obliged to be co-operative. Although that motive attribution is speculative, it must be admitted that Wall Street and the banking industry have had a harder time now than in crises past. We need not be moralizers to concede that people having it worse than what they've been accustomed to can become resentful as a result. "They-owe-us-now" is the product of said resentment.
- The bailout being administered by ‘public-spirited' ex-Wall Streeters is merely nepotism in the making; it's the revolving door. One advantage that a disinterested person from another walk of life has over a former colleague turned adversary is that the former has no need to stay on the good side of the other party. It's not easy being dumped by all of one's former friends – especially for a former executive turned public servant. This suggests that Secretary Paulson will give his former colleagues an easy ride in ways that a career civil servant wouldn't.
A Statecraft-Level Kicker
One of the paradoxes of current American life is the U.S. government being continually blamed for fiscal irresponsibility after toning down the deficit spending to a large degree. This reversal took place in the 1990s during the Clinton Administration and the Gingrich Congress. Had 9/11 not intruded, this relative restraint would have likely continued during the Bush Administration regardless of which party controlled Congress. "Bill Clinton Democrats" in Congress would have kept it going as well.
Contrast this turnaround with the private sector, where continually increasing debt levels oddly unite Wall Street and Main Street. There's no sign of a turnaround there – only occasional retrenchments. This contrast raises the question: why is the government continually fingered for fiscal irresponsibilities instead of the private sector?
The answer lies in the childhood training of today's movers and shakers, including the debt-buccaneers. They grew up in a time when deficit spending by the government was presented as an unalloyed good. Their rationales for the bailout, as well as their own financial conduct, clearly show that imprinting. After all: if it's good for the government to borrow and spend, then why wouldn't it be good for the private sector to do so too? Especially since the private sector may very well allocate resources more efficiently?
When it comes down to it, the current ‘laissez-faire' talk in the popular media is just Chicagoite optimization arguments layered over a thoroughly Keynesian base. The current debt "privateers" are just applying the lessons they soaked up when still Future Leaders and good citizens-in-waiting, ones which imply that deficit spending and further debt incurrence are economic boons.
Novenas and months-long spiritual retreats are largely out of style, so these people are too set in their ways to change fundamentally. On the other hand, the current eager-to-succeed youngsters aren't.
If the current crop grow up seeing the government saving the taxpayers grief through being patient, then they'll soak up the virtue of financial patience by osmosis – just as today's movers and shakers sucked up the deficits-are-good credo when children themselves. President Bush promised that only the U.S. government has the "patience and resources" to extract full value out of currently radioactive securities, mortgages and other bank assets. If the Treasury lives up to that promise, we might see unexpectedly prudent and patient high achievers knocking on Wall Street's door fifteen years hence.
Daniel M. Ryan is a regular columnist for LewRockwell.com, and has an undamaged mail address here.