Sunday, November 16, 2008

Why Bailouts Are Impractical

There are unanswerable moral objections to the Feds bailing out everyone under the sun. I'll cover them in detail in a subsequent post. For the moment, consider some of the practical effects that are contrary even to the goals proposed by the advocates.

Offering Federal money to failing businesses in order to keep them from failing just encourages more corporate welfare.

Regrettably, evidence of that isn't hard to find. The Hartford, an insurance company with 2007 revenues of nearly $26 billion and net income of $2.9 billion, is now standing at the Federal door, hat in hand. Yet, by their own admission, the company is financially sound.
"We are taking these actions as a strong and well-capitalized financial institution looking for maximum flexibility and stability," said Ramani Ayer, The Hartford's chairman and chief executive officer. "Securing capital at the terms available through the Capital Purchase Program could be a prudent course in this market environment and would allow us to further supplement our existing capital resources." [emphasis added]
Clearly, among many other ill-effects, the current rules — if you can label the whims of dictators which change almost daily "rules" — encourage even healthy companies to line up at the trough, lest they be put at a competitive disadvantage.

The various programs, which are the result of HR 1424 giving Paulson essentially unlimited power to do whatever he thinks best to resolve the crisis, shift behavior in other impractical ways, too.

Under the present circumstances, what CEO wouldn't be wiser to wait for a government bailout, rather than liquidate underperforming assets? After all, if Countrywide can expect the Feds to pay more for a defaulted mortgage than they would get by foreclosing, they'd be foolish to suffer the larger loss, no? Foreclosing doesn't just result in a lower return, it consumes valuable staff time, which can be even more expensive in the long run.

That's one of the major reasons that many credit markets remain 'frozen' or sluggish. Investors and executives are waiting for the other shoe to drop. That a new pair full of holes is dragged out of the closet every week doesn't help.

That last phenomenon, in the end, is overwhelmingly the biggest practical problem with the Feds getting involved in the situation in the first place. Financial markets entail huge uncertainty under the best of circumstances. Entire departments exist in most finance-related companies to attempt to measure and mollify it, as best they may. I've actually worked in some and I can tell you, it is rocket science, with often the added complexity of not knowing what the space ship is made of or how volatile is the fuel.

Add as pilot the unsteady hand of a panicked bureaucrat — with the impossible task of trying to analyze markets while lacking information he can't possibly obtain or adequately understand, yet given the power and pressured to "fix it, somehow!" — and you have a recipe for disaster.

We are all now beginning to choke on the toxic fumes.

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