Federal legislators recently passed a $850 billion plan taking many assets off the hands of our troubled financial institutions with the goal of reviving credit markets. While this may at first sound like logical policy that would jump start the staggering economy, the reality is that it is an incredibly flawed one without any successful historical precedent. The policy fails to address the root causes that got America into this disaster in the first place.
Before delving into a complex analysis of the causes of this current banking failure, this report will first address the idea of an economic bailout as a policy itself, and what success, if any, similarly large bailout plans have had.
An economic bailout is a government outlay of taxpayer’s capital to a particular company or industry, with the hope of helping it through a rough time. Instead of just letting it fail, the government feels the need to save the company or industry because of its necessity to the economy. However, the reality is that government bailouts provide no incentive for running more efficient businesses or for correcting the problems that led businesses to such predicaments, because these companies learn that the security blanket of the government will always be there to rescue them if things go wrong. Furthermore, government money and/or protection is as addictive as crack. One only needs to look at the military-industrial complex or Fannie Mae and Freddie Mac to see the truth in that.
When a government bails out a single business, as it has done a handful of times in recent memory, the effects are potentially worse than bailing out an industry as a whole. This is because generally the businesses that are saved are the biggest ones, such as AIG in the insurance industry. In a free market, companies would expand only when they deemed it profitable to do so. However, in a world with bailouts they will expand and merge with other companies—even when it may not be particularly profitable—in order to avoid the fate of companies who are not quite “big enough” or “important enough” to the economy to be saved, such as Lehman Brothers. Hence, government bailouts indirectly lead to a greater trend towards non-profitable monopolizations, which, if allowed to fester, will lead to a whole new economic crisis. Our “solutions” to this crisis are sowing the seeds of the next one.
America has a long and not-so-rich history of bailing out the economy. However, the only historical example comparable to the currently proposed bailout plan is the New Deal. While the New Deal was more all-encompassing, affecting all areas of the economy and often going beyond merely handing out government money, it is the only “bailout” that comes close to this one in terms of outlay of capital. What we learned from the New Deal is that government intervention during the Great Depression had little effect on the economy. Unemployment rate, GDP, and other indicators of economic vitality did not show any statistically significant improvement during the prewar years.
If this precedent is not enough to show that a bailout is not an effective policy, one need only look at the bailouts and government-assisted buyouts that have already been implemented: Bear Sterns, Fannie Mae and Freddie Mac, AIG, and Washington Mutual. Directly after the government-assisted buyout of Bear Sterns and the takeovers of Fannie Mae and Freddie Mac, the economy stabilized for a short while, only then to continue on a downward spiral. These examples prove that bailouts are only holding off the inevitable. Albert Einstein once said that “insanity is doing the same thing over and over again and expecting different results.” Right now I think it is safe to say our government may be insane, since the failure of one bailout has convinced them that the next one will save the economy. Over the course of this crisis the bailouts have grown larger and larger, until finally we are at the point today where $700 billion is going to be used to save failed companies, thus enabling them to fail again.
It is obvious, though, that something must be done. But, just because something must be done, does not mean that the bailout was that “something” our economy needed. Rather, it is important to analyze the current situation and figure out how we arrived here (it did not happen overnight). Even if this crisis did happen because of the “greed of Wall Street,” it is important to ask if a bailout is the best way to curb this greed.
America finds itself in its current economic predicament precisely because of its aforementioned long history of government bailouts, because of the large amount of government intervention in today’s economy, and even because of the greed on Wall Street. The two of firms that started the downward spiral, Fannie Mae and Freddie Mac, were governmental sponsored enterprises (GSEs), meaning that they functioned as private companies but were backed by American taxpayers. This caveat allowed them to take numerous risks in purchasing shady mortgages that more practical companies would have avoided. However, due to their government sponsorship, they were free to pursue profit at a risk that the free market would never allow.
Many of the corporations that have failed in similar fashion [to Fannie and Freddie] were so large and had so many lobbyists in Congress that, even if those realities did not play conscious roles in their thinking, they gained a sense of invincibility. They knew that if they failed the government would absorb the impact, as it is doing now. Of course another factor was business leaders’ desire to pass the buck on to the next person. When companies realized they had made bad investments, they would devise tricky financial schemes with the goal of passing the costs onto another party. Of course, such devious attempts just recently blew up in their faces.
So what, then, is the best way to clean up this mess? The government has decided on a bailout, but this article has already outlined the many inherent flaws and problems involved with bailouts, the most important of all being the fact that it simply does not work. Rather, it would have been a much better policy for the government to simply have allowed these companies to fail. In the short term many would have suffered, employees and investors would have felt the brunt of the load, and others would have been indirectly affected. However, does the bailout leave us in a less calamitous situation than if the companies had simply been allowed to fail? The stock market is still falling, people are still defaulting on loans and creditors are still not lending.
In the long run, permitting failure would have created responsible companies who acknowledge that scheming today does not lead to profit but to failure. More importantly, permitting failure would have created more knowledgeable and informed investors who would not decide to put their money into a company based on its brand name or safety rating, but who would utilize resources to determine what they believe is the best way to invest their savings.
America missed a golden opportunity to return to its roots of pure, unfeathered capitalism, which we have wrongly deviated from since the New Deal. When the House rejected the initial bailout plan there was a glimmer of hope, but with the passage of the new bailout bill it is clear that America’s economic future will continue to be determined by the government rather than the rightful determiner, the free market.
