Topic: Finance, Banking & Monetary Policy

Wall Street Bailout Promotes More Washington Corruption

Naive and/or deceptive politicians often claim that sleaze is the enemy of good government, but the real truth is that government is the biggest friend of corruption. Simply stated, when politicians redistribute more than $3 trillion (and more indirectly via regulation), lobbyists and interest groups will line up to stick their snouts in the trough. The Wall Street bailout is an excellent example of this distasteful practice. The headline of a recent New York Times story summarizes the problem, noting “Lobbyists Swarm the Treasury for a Helping of the Bailout Pie.” The excerpt below reveals some of the corruption that is so pervasive in Washington. The most absurd part of the story is the quote from a Treasury Department official who says the government shouldn’t pick winners and losers - a rather strange statement since the bailout exists so that government can pick winners and losers:

When the government said it would spend $700 billion to rescue the nation’s financial industry, it seemed to be an ocean of money. But after one of the biggest lobbying free-for-alls. in memory, it suddenly looks like a dwindling pool. Many new supplicants are lining up for an infusion of capital as billions of dollars are channeled to other beneficiaries like the American International Group, and possibly soon American Express. …The Treasury Department is under siege by an army of hired guns for banks, savings and loan associations and insurers – as well as for improbable candidates like a Hispanic business group representing plumbing and home-heating specialists. That last group wants the Treasury to hire its members as contractors to take care of houses that the government may end up owning through buying distressed mortgages. …”Unfortunately, I don’t have a lot of good news for them individually,” said Jeb Mason, who as the Treasury’s liaison to the business community is the first port-of-call for lobbyists. “The government shouldn’t be in the business of picking winners and losers among industries.” Mr. Mason, 32, a lanky Texan in black cowboy boots who once worked in the White House for Karl Rove, shook his head over the dozens of phone calls and e-mail messages he gets every week. “I was telling a friend, ‘this must have been how the Politburo felt,’ ” he said. …The first wave of lobbying came in early October when Mr. Paulson announced the plan to buy troubled mortgage-related assets from banks. The Treasury said it would hire several outside firms to handle the purchases, and would dispense with federal contracting rules. Law and lobbying firms that specialize in government contracting fired off dispatches to clients and potential clients explaining opportunities in the new program. Capitalizing on the surge of interest, several large firms, including Patton Boggs; Akin Gump; P & L Gates; Fried, Frank, Harris, Shriver & Jacobson; and Alston & Bird, have set up financial rescue shops. Alston & Bird, for example, highlights its two biggest stars – former Senator Bob Dole and former Senator Tom Daschle. Mr. Dole “knows Hank Paulson very well” and has been “very helpful” with the financial rescue groups, said David E. Brown, an Alston & Bird partner involved in its effort. “And of course, Senator Daschle is national co-chair of the Obama campaign,” Mr. Brown added, noting that because Mr. Daschle is not a registered lobbyist, his involvement is limited to “high level advisory and strategic advice.” Ambac Financial Group, in the relatively obscure bond insurance business, never needed lobbyists before, said Diana Adams, a managing director. But its clients persuaded the company to hire two Washington veterans – Edward Kutler and John T. O’Rourke – who helped arrange a recent meeting with Phillip L. Swagel, an assistant Treasury secretary. “We haven’t really asked for much in the past,” Ms. Adams said. …Some lobbyists, Mr. Mason said, had called him even though they did not have any clients looking to get into the program or worried about its restrictions. They were merely seeking intelligence on which industries would be deemed eligible for assistance. He suspects they were representing hedge funds that wanted to trade on that information.

Helicopter Paulson

Government equity investment or rescue of the broader (non-financial) economy is a mistake.  It will damage economic efficiency in the long-term by diluting the value of private shareholders and reduce incentives for cost cutting and product quality innovations.

Of course, the current focus is not on long-term incentives but on how to shorten and moderate the current economic recession.  The constantly changing mix of initiatives from the Treasury suggest:

1. A lack of knowledge/vision about what to do–so they’re throwing money at everything that moves in the hope that something will work.  These ex-Goldman Sachs personnel that make up the Paulson team are probably not economists–and certainly not good ones.  The majority are probably MBAs with little understanding of how things really work in the economy. They probably have a microeconomic firm-specific orientation and management skills that are unsuited for their current responsibilities. If I’m wrong, I’d be very surprised. If I’m right, it’s showing.

2. An attempt to assuage competing political constituencies and provide benefits to potential future supporters.

3. An attempt to distribute wealth to those people/firms that the next Congress and president won’t support–by tying their hands through government ownership of firms.

4. A deliberate and cynical attempt to damage the economy even more to make life difficult for the Obama administration.

I think # 4 is cynical on my part. But although unlikely, it is not impossible given how polarized the political atmosphere was during the GW Bush presidency.

Broad government involvement in private firms to solve the economic crisis is a dangerous turn.  The shareholders in these firms took risks and should bear the consequences of their decisions. If they sink, the economy may recover faster as other businesses are created over time in non-housing and less energy intensive sectors.  Supporting existing, inefficient firms run by poor decision makers is likely to prolong the recession because keeping those firms and their managers afloat won’t help to restore market confidence.  And, this policy will encourage future investors/managers to take even riskier decisions under expectations of yet another government bailout if they fail. Finally, government debt-financed wealth injections are worsening the nation’s finances–we’re already swimming in huge and unpayable entitlement obligations to a growing number of retirees, disabled, poor, and the sick.

The government purchase of securitized auto loans is probably intended to insure auto company creditors, who would otherwise become bankrupt and prolong the credit-flow freeze.  It’s another source of bad assets on bank and non-bank financial firm portfolios that’s contributing to the market failure in that sector.  I’m more sympathetic to the original TARP idea than government officials seem to be. That way the government’s involvement in the private sector will be limited and it will remove bad assets from their balance sheets–which are responsible for the pervasive uncertainty among financial market players and is causing the credit freeze.  But under TARP, government officials don’t get to choose whom to support–they must buy up assets from whoever is currently holding them–be it domestic or foreign firms, “friends and relatives” or “strangers and enemies.”

Correspondence with a Presumed Proponent of Auto Bailouts

As a supporter of free trade, I’m used to getting angry letters and emails whenever I do media. Below is one of the more civil, reasonable emails, which I received following my appearance on last night’s Lou Dobbs:

I would have liked to see the rest of what you said about the auto industry on the show but what I did see angered me. You said something to the effect that bad business decisions by the Detroit automakers should not get them a bail out and that one of them should be allowed to fail is what I heard you say. I am assuming that the out of control greed that has run unchecked for years and terrible government policies have allowed the investment banks to basically destroy thousands of peoples lives should deserve a bail out. My thinking is that none of them should get one penny. As for the auto companies failing. Lets see. The banks fail then they will not lend to anyone now. I with a 780+ credit score can no longer get a loan for a car which then hurts the auto company is one cause. The fact that people are losing their jobs by thousands is not helping, the people losing their houses and high gas prices are killing the sales of cars. I don’t know if you know that if lets say GM goes under 100’s of thousands jobs could be lost. Engineers, designers, line workers, computer guys, and so on, not to mention all the other business that supply the automakers. Did you give any of this any thought? I also would like to know what you think about the good paying jobs that go overseas. Plus can you tell me one benefit to this Global economy has had for the USA. Please don’t give me the cheaper prices line either.

Here’s my response:

Thanks for your thoughtful comments.  More often than not, the messages I receive from people who disagree with my perspective tend to be nasty and poorly articulated.  So, yours is a welcome dissent.

I am opposed to interventions of any kind. The Wall Street bailout and the subsequent partial nationalization of what were private U.S. financial institutions is in essence a penalty on prudent behavior and a subsidy for risk taking. It is patently unfair and grievously unwise to use taxpayer dollars to insulate people or institutions from the consequences of their actions, as it is unfair and unwise to deprive risk takers of the full fruits of their efforts.

The story is no different in the auto industry. Yes, the industry employs thousands of workers and there are many jobs in related industries that depend on a healthy (or at least functioning) auto industry. I am sympathetic to your suggestion that auto’s woes are at least in some part attributable to the credit freeze, which is a response to, among other things, circumstances beyond its control. But there’s much more to the picture than the one you seem to want to paint of the auto industry as an innocent victim. 

The fact is that much of the Big Three’s problem is self-made. The credit crunch and the contraction of demand is just the latest dark cloud, and a problem that affects all industries, not just autos. Thus, if there is a bailout for Detroit, where, how, and why do we draw the line to exclude other manufacturers, home builders, coal miners, and masseuses, who are all suffering from the same contraction in demand caused in part by the credit crunch? Don’t tell me we should bail everyone out. For starters, we can’t afford that.

Detroit’s problems predate the financial meltdown. Management and labor, together, consigned the Big Three to a future of troubles when ridiculously liberal work rules that flew in the face of basic economics were agreed upon, requiring management to pay workers at 90% of their salaries when they were laid off. The “Cadillac Platter” of health and retirement benefits granted to the UAW also dramatically raised the cost of producing vehicles at unionized auto plants in the United States. And let’s not forget about the far-in-excess-of-average manufacturing wages that auto workers “won” through concessions by management over the years. Management agreed to all of these conditions — and labor pushed them — because both sides assumed that the U.S. governent would come to the rescue (that the industry was too big to fail) when the chickens came home to roost over this inefficient, uncompetitive cost structure. That, to my mind, reflects labor’s and management’s greed.

On the demand side, Big Three management demonstrated an egregious failure of imagination, if not downright dereliction of duty, in assuming that large pick-up trucks and SUVs would never fall out of favor. Of the top 10 selling cars (not trucks or SUVs) in the United States, Big Three offerings have barely made the list this decade. Not one has been a top 5 seller. Shouldn’t producers try to make things that people want to consume before scapegoating their failures and seeking government bailouts?

One of the points I made in my interview with the Lou Dobbs show that didn’t make it to air is that a bankruptcy and liquidation or two in the auto industry wouldn’t be the end of the world. In fact, it would be a welcome development for the producers and their workers who remain in operation. They would be able to compete for a larger share of a pie that is currently shrinking, but will again expand. Which companies remain and liquidate should be determined by market forces, not by the coercive, thieving actions of the Michigan congressional delegation and Governor Granholm. 

I think an instructive example for the auto industry is the U.S. steel industry. During this decade, the steel industry responded to waning fortunes and dozens of bankruptcies by finally allowing unproductive, inefficient mills to shut down. As a high fixed cost industry with dozens of producers at the time, the industry finally did what is should have done long ago: it consolidated. In 2001, 12 firms accounted for 75% of U.S. hot-rolled steel production. In 2007, 3 firms accounted for over 80 percent of hot-rolled steel production. The consolidation has afforded the steel industry an alternative to requesting bailouts in the face of declining demand: it curtails output, which affects prices favorably for the mills. If there were fewer automakers in the United States making products Americans wanted to buy, and if labor costs were more variable and less fixed by unaffordable contracts, the auto industry might be similarly equipped to weather storms.

As to your questions about my views on trade, there is plenty of commentary and analysis on our website (www.freetrade.org) that I invite you to check out.

Cato Debates Potential Auto Industry Bailout on NPR.org

Cato Senior Fellow Daniel J. Mitchell participated in a debate yesterday on NPR.org that discussed the possible implications of a government bailout of the U.S. auto industry. Mitchell argued against it, and in the middle of the debate, NPR held an online poll that showed that 68 percent of listeners agreed with him.
Quotes from Daniel Mitchell pulled from the debate:

  • Consumers, acting in the marketplace, should determine which companies succeed or fail. Business success should not depend on which companies can hire the slickest lobbyists.
  • Every dollar the taxpayers send to Detroit will be one less dollar that will be available in the productive sector of the economy. This means fewer jobs in other industries, fewer jobs in the service sector, and fewer jobs in all other fields.
  • A federal bailout deprives other sectors of the economy of resources. Moreover, a bailout delays the much-needed restructuring of the US auto industry, much as handouts to the proverbial worthless brother-in-law enables him to continue sitting on the couch all day instead of putting his life back in order.
  • Foreign companies with plants in America are much more successful. It baffles me that politicians want to reward incompetence. Actually, it’s not that surprising. Detroit probably spends a lot more on lobbyists. Too bad they don’t put an equal amount of time and effort into improving their goods and services.
  • I don’t care if the bailout is profitable for government. The economic damage occurs because politicians interfere in the allocation of resources. Government intervention is a big reason why European welfare states grow slower, have higher unemployment, and lower living standards than America. We should not emulate nations such as France and Germany.
  • Five years ago, a merger of GM and Chrysler would probably be killed by the antitrust bureaucrats. Now the politicians want to subsidize the merger?!?
  • Bankruptcy almost surely will make consumers a bit more wary, but a bailout ensures that the auto companies won’t change the bad policies that got them in trouble. Better to restructure now. You don’t cure an alcoholic by giving him more to drink.

You can follow the entire debate here.

Does Harper Support Regulation of Gambling and Financial Services?

My post yesterday regarding Members of Congress who voted to exempt financial derivatives from state gambling laws created a firestorm of controversy. Well, two people asked me about it, anyway …

(A new WashingtonWatch.com post on the presidential candidates who didn’t help create our economic problems is available for your perusal, by the way.)

“Why would a libertarian think it’s bad to exempt anyone from regulation? Do you support gambling laws? Do you support financial services regulation?”

These are all fair questions, given my objection to preempting state gambling laws in this case. So let me expand on this observation from my earlier post:

Many gambling laws are nanny-statism, of course, but if they’re going to go away, they should be repealed by the legislatures that wrote them. This federal preemption gave special permission to certain parts of the financial services industry to run a huge gambling operation masquerading as a market in real assets.

I’m quite a bit less a fan of preemption than many of my colleagues. There are fair-minded people who believe that national markets call for national regulatory regimes to replace the states’. As commerce has become national, the Commerce Clause has become a grant of authority to regulate national markets, they appear to believe.

I’m not convinced. Given the nation’s experience under the Articles of Confederation, the Commerce Clause was included in the Constitution to prevent states from regulating parochially - that is, for the benefit of local interests over out-of-staters. The Constitution gave Congress authority to regulate commerce “among the states” - which, if words have meaning, is something narrower than just regulating all commerce.

So when state gambling laws interfere with an interest capturing the sympathy of a majority in Washington, D.C., that doesn’t necessarily empower Congress to withdraw state authority. Congress is supposed to prevent only state parochialism, not every bad idea coming out of a state legislature.

If we are to have a healthy political economy, debates about state gambling regulations should be taken to each state that enacted them. The merits of freedom and personal responsibility should be made clear there so they win majorities once again.

The alternative preferred by many is a shortcut: trumping states by moving power to the federal level. This is not a felicitous trend, and its end-point - a remote national government with plenary power - is not good for liberty.

Gambling regulation is nanny-statism, but I wouldn’t go and kick the legs out from under state anti-gambling regulation through federal preemption - especially not for one narrow part of the financial services industry. This is not a game, where any loss for regulation is a gain for liberty.

If responsibility for self-protection against gambling is going to be restored to people in a given state, the legislature of that state should repeal the anti-gambling laws, signaling people that they are once again responsible for themselves. What happened here was that Congress trumped state power and withdrew the protection of state anti-gambling regulation without signaling to anyone that there were risks to be encountered. What looked like asset-based financial services to all but a few was in fact gambling.

The Congress helped perpetrate a deception about what was going on with financial derivatives - and just because some regulation went under the tires, that isn’t a victory for liberty.

Bailouts: Where Will They End?

“There’s no logical end to it,” Cato Senior Fellow Gerald P. O’Driscoll Jr. said to Neil Cavuto on Fox Business. He’s talking about the incredible expanding bailouts. It started with Bear Stearns in March and then homebuilders in April. Then Fannie Mae and Freddie Mac in September, and after that the deluge. AIG, announced at $85 billion but quietly increased to $123 billion so far, and the $700 billion centerpiece and then money market funds and then bank nationalizations and an increase in the federal guarantee to bank depositors. Where will it stop?

Friday’s papers noted that the head of the FDIC said that the federal government might start guaranteeing home mortgages. On Saturday we learned that insurance companies want to get a piece of the money. Yesterday the Treasury said that automobile companies–which already got their own $25 billion program–might also be eligible for the general “financial rescue plan,” and their success might encourage other industries to try to get in on it.

As I noted before, Congress is talking about “a second economic stimulus package, totaling $50 billion in the form of money for infrastructure projects, relief for state governments struggling with rising Medicaid costs, home heating assistance for the Northeast and upper Midwest, and disaster relief for the Gulf Coast and the Midwestern flood zone.” And Transportation Secretary Mary Peters wants “an $8 billion infusion” for the federal highway trust fund.

Where does all this money come from? The total cost is hard to estimate, because we don’t know how many of these guarantees will actually result in payments. But some analysts are talking about a total bill of $2-3 trillion. Given the underestimate on the cost of the Iraq war, we shouldn’t have confidence in any claims that it will be less. So where does the money come from? Even Obama doesn’t want to raise taxes that much. And if you tax Americans to bail out as many Americans as we’re now talking about helping, eventually you’re going to be taxing people to bail themselves out. In fact, the government is likely to borrow some of the money and have the Federal Reserve create more of it. That process seems to be under way, as Greg Mankiw and Jeff Hummel have discussed. How can that astounding and unprecedented increase in the monetary base not lead to inflation, even hyperinflation? We’ve already decided to tax the prudent and thrifty to bail out the imprudent and irresponsible. Now the prudent may face a danger even worse than taxes: inflation that erodes their hard-earned savings.

Howard Baker famously called Ronald Reagan’s tax cuts a “riverboat gamble.” This is more like a “Celebrity Solstice gamble.”

Members of Congress Who Voted for the Financial Crisis

In late 2000, with the budgeting and spending process in collapse, Congress hurriedly passed a mammoth spending bill called the Consolidated Appropriations Act, 2001. It contained a provision preempting state regulation of financial derivatives under gambling or “bucket shop” laws. The result less than a decade later was the out-of-control market for credit default swaps that has caused so much financial, and perhaps economic, chaos.

One hundred fifty-five members of Congress who voted for the Consolidated Appropriations Act and the preemption of state law are still serving and are up for election next week. Twenty-two senators who stood by as the bill passed by unanimous consent are also up for election Tuesday.

Details are in a WashingtonWatch.com blog post entitled “Did Your Representative Cause the Financial Crisis?

Many gambling laws are nanny-statism, of course, but if they’re going to go away, they should be repealed by the legislatures that wrote them. This federal preemption gave special permission to certain parts of the financial services industry to run a huge gambling operation masquerading as a market in real assets.

All this is a good illustration of why it’s harmful for Congress to let the annual budgeting and spending process go off the rails. Maybe voters will hold some of their representatives accountable.