Tag: Bailout

Too Big to Fail

One of the most pernicious public policies aggravating the financial crisis is that of “too big to fail.” The doctrine states that some banks (now financial institutions generally) are so large that their failure would incur “systemic risk” for the financial system. That sounds terrible and it is intended to. Financial services regulators and Treasury secretaries use it to frighten small children and congressmen. How can an elected official vote to incur systemic risk? He must vote to approve the bank bailout of the day. In fact, people who use the term cannot even agree among themselves as to what it means, much less what causes it and, therefore, what the appropriate response would be. I suggest the reader substitute the phrase “too politically connected to fail” whenever he sees “too big to fail.” What follows will then be rendered intelligible.

Banks, Bailouts, and Political Pressure

The Washington Post reports:

Sen. Daniel K. Inouye’s staff contacted federal regulators last fall to ask about the bailout application of an ailing Hawaii bank that he had helped to establish and where he has invested the bulk of his personal wealth.

The bank, Central Pacific Financial, was an unlikely candidate for a program designed by the Treasury Department to bolster healthy banks. The firm’s losses were depleting its capital reserves. Its primary regulator, the Federal Deposit Insurance Corp., already had decided that it didn’t meet the criteria for receiving a favorable recommendation and had forwarded the application to a council that reviewed marginal cases, according to agency documents.

Two weeks after the inquiry from Inouye’s office, Central Pacific announced that the Treasury would inject $135 million.

As we’ve said here many times, going back to 1983, when government is in the business of making economic decisions, you inevitably get more lobbying, more campaign spending, and more political influence on economic decision-makers.

The Government Is Not the Economy

Rep. Zoe Lofgren (D-CA) is very upset that the Obama administration has rejected the California state government’s request for a bailout. She tells the Washington Post:

This matters for the U.S., not just for California. I can’t speak for the president, but when you’ve got the 8th biggest economy in the world sitting as one of your 50 states, it’s hard to see how the country recovers if that state does not.

First, presumably Lofgren knows that the federal government is projecting a deficit of $1.8 trillion for the current fiscal year – so where is this emergency aid for California to come from?

But perhaps even more importantly, Lofgren seems to confuse the state of California with the State of California. That is, she confuses the people and the businesses of California with the state government. There’s no clear and direct relationship between the two. The state government is currently running a large deficit and is warning of a “fiscal meltdown.” Of course, as it continued to issue claims of fiscal meltdown and painful cuts over the past many years, California has continued to spend. The state has nearly tripled spending since 1990 (doubled in per capita terms).  It went on a spending binge during the dotcom boom and never adjusted to the lower revenues after the bust.  During the Schwarzenegger years the state has increased spending twice as fast as inflation and population growth. What were they thinking?

But a bailout for the government won’t necessarily help the recovery of the state’s economy. In fact, by increasing taxes and/or borrowing, it would likely weaken the national economy. And by encouraging continued irresponsible spending by the state government, it would just be an enabler of destructive policies that suck money out of the productive sector of California’s economy. We all want the California economy to recover. But that’s not the same thing as giving more money to the California government.

Week in Review: Health Care Battles, Pay Caps and North Korean Prisoners

Will Obama Raise Middle-Class Taxes to Fund Health Care?

President Obama is promoting an expansion in federal health care spending, and Democratic leaders are scrambling to find ways to pay for it. The plan is expected to cost about $1.5 trillion over the next decade, but the administration has promised that health care legislation won’t add to already huge federal budget deficits. In a new paper, Cato scholars Michael D. Tanner and Chris Edwards argue that expanding government health care will likely involve huge tax increases on the middle class.

Tanner warns of “Obamacare” to come, saying that Obama’s new health care plan will give “government control over one-sixth of the U.S. economy, and over some of the most important, personal, and private decisions in Americans’ lives.” Don’t miss Tanner’s in-depth analysis of the new health care plan that is making its way through Congress, which “would dramatically transform the American health care system in a way that would harm taxpayers, health care providers, and — most importantly — the quality and range of care given to patients.”

A part of the plan would include “public option” (read: government-run) health care, which would allow the government to compete against private health care providers. Tanner says it would be the first step toward wiping out the private insurance market as we know it:

Regardless of how it is structured or administered, such a plan would have an inherent advantage in the marketplace because it would ultimately be subsidized by taxpayers. It could, for instance, keep its premiums artificially low or offer extra benefits, then turn to the U.S. Treasury to cover any shortfalls. Consumers would naturally be attracted to the lower-cost, higher-benefit government program.

…It is unlikely that any significant private insurance market could continue to exist under such circumstances. America would be firmly on the road to a single-payer health care system with all the dangers that presents. That would be a disaster for American taxpayers, physicians, and—most importantly—patients.

Treasury Seeks to Control Executive Pay Across the Private Sector

Fox Business reports, “The Treasury Department on Wednesday took new steps to rein in executive compensation, saying the Obama Administration would introduce legislation that could create stricter limits on pay; it also appointed an official to head up efforts on the issue.”

In a 2008 Policy Analysis Ira T. Kay and Steven Van Putten explain the misconceptions many people have about executive pay, and why the market is a better arbiter than any bureaucrat in Washington:

Such populist sentiments are often based on misunderstandings about the role of corporate executives in the economy and the vigorous competition that exists for these highly skilled leaders. In the past, federal regulatory efforts based on such misunderstandings have generated unintended consequences, which have damaged the economy and hurt the ability of the market for executives to self-regulate over time.

The labor market for executives and the associated pay levels are already subject to high levels of regulation. Indeed, U.S. corporations are subject to more stringent executive pay disclosure requirements than corporations anywhere else in the world. Before additional regulatory and legislative efforts are unleashed, policymakers should examine the rationale for current pay structures and the strong links between executive pay and corporate performance.

In a Washington Times op-ed, Alan Reynolds says efforts to cap executive pay are wholly misguided:

Congressional hearings to barbecue Wall Street executives are as fun as a circus, but with more clowns. Presidential politics is now taking such political distractions to a lower level.

…Most top executives who were actually in charge during the craze of overinvestment in mortgage-backed securities have been fired. Executives who are fired are not in a position to be “giving themselves” anything.

In reality, top executives are mainly paid by accumulating a big stockpile of company stock and stock options. Estimates of annual CEO pay that Congress and the press have been focusing on look as high as they do only because of the high value of restricted stock or stock options at the time.

Writing in 2007 (before the first round of major bailouts), Cato scholars Jerry Taylor and Jagadeesh Gokhale took it a step further: “Pay Bosses More!”:

Excessive executive compensation harms no one but perhaps the stockholders who put up with it. And stockholders put up with it because there’s good reason to believe that sizable CEO compensation packages help – not harm – corporate performance, which redounds to their benefit, and that of the firms’ workers.

Companies pay workers what they must to deliver their products and services to the market, and supply and demand establishes executive compensation packages the same way it establishes consumer prices. Any overcompensation comes out of the firm’s bottom line – at a loss to the shareholders, not the workers.

North Korea Sentences Two U.S. Journalists to 12 Years Hard Labor

Two American journalists were convicted of entering North Korea illegally while on assignment, and exhibiting “hostility toward the Korean people.” This week, a North Korean court sentenced them to 12 years in a labor prison.

Cato scholar Doug Bandow comments:

Washington should publicly downplay the controversy and present the issue to the Kim regime as a humanitarian matter. The Obama administration should indicate its willingness to open a broader dialogue with North Korea, but indicate that positive results will be possible only if Pyongyang responds with cooperation instead of confrontation. Releasing the two journalists obviously would provide evidence of the former.

Regrettably, Laura Ling and Euna Lee are political pawns. As such, Washington’s best strategy to achieve their release is to simultaneously reduce their perceived value to Pyongyang and ease tensions between the U.S. and North Korea. Patience may be the Obama administration’s highest virtue and Ling’s and Lee’s greatest hope.

In a Cato Daily Podcast, Bandow discusses what can be done for the American prisoners, and how the U.S. government should react.

Save Free Enterprise—Starting Now

As Dan Mitchell noted below, the U.S. Chamber of Commerce has launched a “Campaign for Free Enterprise” to stop the “rapidly growing influence of government over private-sector activity.” Chamber president Thomas Donohue told the Wall Street Journal that an “avalanche of new rules, restrictions, mandates and taxes” could “seriously undermine the wealth- and job-creating capacity of the nation.”

Indeed. Given the scope and extent of the Obama administration’s assaults on private enterprise — national health insurance, energy central planning, pay czars, abrogation of contracts, skyrocketing spending, and so on – free enterprise can use all the help it can get. I welcome the Chamber to the fight.

But it would be nice if the Chamber had joined the fight for economic freedom a bit earlier, say back in February when many of us were trying to stop the administration’s massive “stimulus” spending bill. That bill’s official cost is $787 billion; with interest, it would be about $1.3 trillion; and if you assume that its temporary spending increases will be extended, it will cost taxpayers about $3.27 trillion over 10 years.

Back then, Donohue had a few criticisms of the bill, but

The bottom line is that at the end of the day, we’re going to support the legislation. Why? Because with the markets functioning so poorly, the government is the only game in town capable of jump-starting the economy.

Or they might even have started defending free enterprise last fall, instead of going all-out to push the TARP bailout through Congress.

Converts to the cause of limited government are always welcome. But we might not need a $100 million Campaign for Free Enterprise if American business had opposed big government when the votes were going down in Congress. Still, better late than never.

A Libertarian Dilemma

What is to be done with the nation’s largest financial institutions, 19 of which have been officially designated as “too big to fail?” When thus guaranteed government protection, such institutions can be expected to take excessive risk and generally operate recklessly. Profits on risky ventures remain privatized, while losses become socialized. That is what happens when you bet with other people’s (that is, taxpayers’) money. I have called the system “casino capitalism.”

The solution, of course, is to end the policy of “too big to fail.” That will not happen soon, however, and we will likely see the government’s safety net extended to more institutions before there is any prospect for its withdrawal. In the interim, the risk-taking appetite of the large banks must be constrained, that is, regulated. What should the classical liberal response be?

MIT’s Simon Johnson has argued, “Anything that is too big to fail is too big to exist.” He favors breaking these institutions up. Chicago’s Gary Becker has suggested imposing progressive capital requirements as a disincentive for financial services firms to grow large enough to become too big to fail. The larger the institution, the higher the required capital ratio.

What cannot in conscience be done is to apply presumptive free-market arguments to such entities. They are not being constrained by market forces. The market’s invisible hand has been replaced by the state’s protective embrace.

A Nation of Lawlessness

The matter of Chrysler’s bankruptcy seems to have rendered quaint our system of checks and balances. President Obama is breaking the law and the other two branches are letting him get away with it. One can probably understand how a smitten public might casually allow this president a stipend of unconstitutional acts, since he doesn’t scowl like Nixon or stutter like Bush. But, even a popular president (in particular, a popular president) must be held in check by the legislative and judicial branches.

And that’s not happening.

On Tuesday at 4:00 pm, Justice Ruth Bader Ginsburg “stayed pending further order” the bankruptcy-related transactions of Chrysler, giving hope the Supreme Court might hear the appeal filed on behalf of certain Indiana state pension and construction funds, who claim that their property rights as secured creditors were violated by the forced sale and that the use of Troubled Asset Relief Program funds to support Chrysler and facilitate its restructuring was illegal. Only 28 hours later, the Supreme Court decided against taking the appeal, despite the seemingly compelling issues at hand.

Just as the Bush administration was telling Congress last September that there was no time to debate the merits of a financial bailout and that the only course was to give Treasury Secretary Paulson carte blanche immediately to spend $700 billion, the Obama administration was telling the Supreme Court this week that time was of the essence and that Fiat would walk away from the Chrysler deal if it wasn’t allowed to proceed right away. Was that the decisive factor in the Supreme Courts rejection of the appeal? It seems to me the appeal contains some serious constitutional issues worthy of judicial consideration (consideration that goes beyond merely rubber-stamping the Obama administration’s pre-packaged, politically-driven bankruptcy plan for Chrysler, which is what Judge Gonzalez appears to have done).

But it’s now a done deal, possibly facilitated by illegalities.

I’m struck by the relative quiet about this issue (in the mainstream media and the blogosphere). Maybe we’re all just too numb and shell shocked by the blitzkrieg of government interventions over the past 9 months that it’s no longer possible to feel alarmed or outraged by just another government act that would have been unthinkable this time last year.

Well wake up!

There is a compelling legal argument against using TARP funds to support automobile producers. (Obviously, there is a compelling economic argument, as well.) Convincing the courts to hear the argument and subsequently persuading judges (probably up to the Supreme Court) of its merits will likely be the last chance to spare us the nationalization of General Motors.

As you may recall, there wasn’t a whole lot of clarity about how the Treasury’s use of TARP funds would be limited or defined. Lots of discretion was granted the Treasury Secretary. However, Section 101(a)(1) of the law establishing the TARP stipulates:

“The Secretary is authorized to establish the Troubled Asset Relief Program (or ‘TARP’) to purchase, and to make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with this Act and the policies and procedures developed and published by the Secretary.” (My emphasis).

Neither Chrysler nor GM is a financial institution and therefore neither can receive TARP money.  There’s the argument, plain and simple.  Congress authorized funds for a defined use; the executive breached those boundaries, and thus acted illegally. Is it more complicated than that?

President Bush was the first to break the law by authorizing $17.4 billion in TARP funds for GM and Chrysler, circumventing the wishes of Congress, which had recently voted against an auto bailout.  And President Obama has followed suit, providing funding the Chrysler and GM during bankruptcy.

If there’s any doubt that TARP funds were not to be used for automobile companies, consider the fact that the same House of Representatives that passed the legislation creating the TARP in October also passed a bill specifically authorizing the use of TARP funds for automobile companies in December. (There was never a vote in the Senate so it never became law.)  Such legislation wouldn’t have been necessary if the intent of Congress was to allow TARP funds to be used for automakers originally.  Thus, there are two conclusions to draw here. First, the 110th Congress didn’t think the TARP legislation, which it had passed two months earlier, allowed TARP funds to be used for automakers; and second, Congress was too cowardly to bring the matter to the Supreme Court, thereby exercising its constitutional responsibility and allowing the judiciary an opportunity to exercise its.

Let’s hope the judiciary finds the opportunity to check the legality of the executive’s implementation of the legislature’s instructions, as far as the people’s money is concerned.