A Never-Ending Story of Bailouts, Moral Hazard, and Low Economic Growth
The recent economic downturn has created the environment for a new round of bailouts by the government and the Fed. Last time they did this they told us it would be the last one, but anyone who knows our history knew that was not going to stand. Now we are told again that this is an exceptional situation and we must bail out businesses in trouble so that the economy can restart again as quickly as possible. But this is the same argument the government has always made when pushing for a bailout. What is more, every time the government has bailed out businesses, they have promised us that this will not create moral hazard.
Moral hazard here refers to the ability to take risk without fear of suffering the consequences. As I show below, businesses profit by making bad short-term decisions, and when these bad decisions bring them to the brink of bankruptcy, they are bailed out by taxpayers. So, the owners of these firms and their CEOs benefit from the upside, and taxpayers foot the bill on the downside. In what follows, I review the history of bailouts in the US and argue that we must consider bringing an end to bailouts if we want to have the real and sustainable economic growth we desperately need.
Financial Institutions Bailouts 1.0 and 2.0
After the savings and loan (S&L) industry had struggled for many years, government finally came to the rescue. The federal government, at the time under the leadership of President George H.W. Bush, passed a bailout that cost taxpayers $124 billion ($264 billion in today’s dollars). It is important for our purpose here to keep in mind that in the lead-up to this many of these firms had taken advantage of the booming housing market. Many of these companies lent too much money, and when the economy weakened they could not keep up with the losses. This led L. William Seidman, former chairman of the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation, to say that “The banking problems of the ’80s and ’90s came primarily, but not exclusively, from unsound real estate lending.” Hence, these companies were not prudent during the good times and did not plan for a downturn.
This was not the last time financial institutions were bailed out. Banks, along with the artificially low interest rates, were the main cause of the Great Recession. History repeated itself as the federal government stepped in and bailed them out again. We were told that the banks and AIG (American International Group) were “too big to fail” and could not be allowed to go bankrupt because the harm to the economy would be enormous. These bailouts—for AIG, the banks, Fannie Mae, and Freddie Mac—cost the taxpayers $621 billion in today’s dollars, or more than twice the previous bailout. But, aren’t the banks stronger now? one could ask. This is a fair question, yet the banks would be strong if we let them liquidate the parts of their companies that were hit the most. Had we done this we would have a stronger banking system and no moral hazard for the rest of the economy.
Automakers Bailouts 1.0 and 2.0
During the Great Recession the government bailed out the three big automakers in the US. But this was not the first time the government had bailed out a car company. Chrysler had already been bailed out in 1979, when they got $1.5
Article from Mises Wire