No Such Thing As A Free Lunch

The issue of governments bailing out corporations has been a contentious one of late, and I thought I would offer some thoughts on the matter. In my view, there are two conflicting motivations on this issue

1. Firms that take excessive risk or firms that cannot compete in the marketplace must be allowed to fail. If they know they will be bailed out, it only encourages further risk-taking, because all the upside is there but the downside is effectivley limited. If risky or uncompetitive firms are allowed to survive, they will eventually damage the entire framework of capitalism.

2. Governments have an important role to play in protecting their citizens from large-scale problems that affect them, but were not of their own making. If a major commercial bank were to fail, for example, many consumers would be at risk of losing their deposits, investments and insurance. In this case, the need to protect consumers outweighs the need to punish firms that take risk. However, it must be clear that these corporations, as vital as they are, cannot expect a free lunch.

Applying these two principles to the current situation, one can see that some of the bailouts that have happened were undoubtedly necessary. The AIG bailout is a good example of this. Additionally, the use of public funds to buy securitized mortgages from ailing banks strikes a good balance of helping these institutions well still providing taxpayers with the potential of getting their money back eventually.

Conversley, I strongly disagree with some of the actions that have been taken, as well as some that might occur in the future. Bailing out investment banks, for example, is something I am strongly against. The collapse of these institutions would result in reletively low impact on third parties, and their faliure would strongly disincitivise mispricing of risk in the future.

On a similar note, U.S. automakers should not be bailed out forever. They are far-reaching enough that a one-time rescue might have been justified, but problems will not be solved by throwing money at uncompetitive firms. That will only delay the inevitable. The detroit automakes have had plenty of time and money to try and turn things around, and have failed. It is time for them to either consolidate or break apart, into units that can be competitive again.

To this point, we have not seen serious problems with industries other than finance, insurance and manufacturing, but if we do, I hope that any potential bailout will only target industries whose collapse would severly damage the livelihoods of a majority of third-party citizens. Our money is better spent on other things than on propping up bad gambles by investment banks or uncompetitive automakers.

For $700 billion we could put a man on Mars, and I'd rather do that than save the jobs of I-Banking execs who've pulled in seven figure bonuses for each of the last 6 years. So that better not be where that money goes.