Political Diatribes

Another conservative take on the world around us

Why All the Bailouts Will Ruin Capitalism and Move us Into Socialism

Posted by The Diatribe Guy on December 11, 2008

bucket of waterWe’ve all heard the hand-wringing about the expensive bailouts and how it will lead to Nationalism and Socialism.  I happen to agree with this, but my take on it is a little different than most of the things I’ve read about it.  I think we actually could provide these bailout packages in a way in which this would not have to be the case.  However, politics being what it is, the way to do this will never happen.  And it will be our demise.  The only question is how long it will take.

Full disclosure:  I am employed by AIG.  It is not my intent here to defend AIG management for things that I think they did wrong, but at the same time I will be defending certain aspects of the behavior that have come to light since the bailout.   Also, I opposed the bailout, and still do, even though I realized then and now that it may have worked against my personal interests.   I’m much more of a “let the chips fall where they may and gummint stay out of the way” type of guy.

That all, said, the bailouts could be worse.  At least they are constructed as loans with the ability to be paid back.  In the case of AIG, many of these unrealized losses could simply unwind and a boatload of the cash paid back.  With the sale of other assets, hopefully the rest can be paid back.   I’m less familiar with the banking arrangements, but this could work out OK.

I say could because I don’t think they will.  First of all, so much precedent has been set that forever more every company of any size will come begging for a handout from Uncle Sam when trouble arises.   Second of all, who really believes everytthing will work out exactly as planned, and all these arrangement will be paid back in full?   If you do, you win a Mr. Optimism award.

I think everyone, even those who oppose the bailouts, recognizes the short-term stabilizing impact of the move.  I don’t deny that reality.  But a sinking ship will still sink until you plug the hole.  Someone can keep bailing out the water (appropriate analogy, eh?) with a bucket and keep it afloat.  But has the problem been solved?  Not really.   When that person is tapped out of energy the boat starts sinking faster.  Someone else less able may then help out and save things for a while, but eventually things get worse and worse untill there is a tipping point where everyone says “it’s time to get out.”   We are, right now, in the “strong guy with a lot of energy can keep us afloat” stage.   I believe we’ve simply delayed the inevitable.

But why do I think this?  I mean, couldn’t it be that the bailout funds will help the companies ride out a recession, get their ducks in a row, and come back stronger in the end?

Well, maybe it could have worked out that way.  But I doubt that it will.

Let me ask everyone a question.  We all agree that AIG mismanaged their risk by getting oversecuritized in derivative instruments.   And if you don’t know what that means, how about “they put too many eggs in one basket.”   But what was your reaction to the big spa party they threw their producers and brokers when that news hit?  How about that expensive golf outing for other producers?   And what do you think about producing more energy efficient cars for the Big Three?   And are you revolted by executives making millions while workers are being laid off?

I am guessing most people have the following intial reactions to those example: (1) Spa party = boondoggle and ridiculous; (2) golf outing = almost as ridiculous; (3) We should be more energy efficient; (4) Any executive making millions while laying off workers is an abomination.

Well, those reactions are all wrong. Or, perhaps, more fairly…  those reactions are wrong inasmuch as people think the government should have a say-so in the matter.

So, here’s the deal.  As soon as private industry accepts government funds with any type of strings attached, political influence, veto-power, etc. this introduces an inefficiency into the market that will hinder long-run performance of that market.   While it may be true that the funding provides short-term stability, and allows us to avoid (or more likely, delay) the pain of a sever depression, the long-run impact of this will be a net negative.

None of us like to go through difficult times.  It’s an understandable reaction.  But I’m truly a believer that if this thing were allowed to play out, as difficult as it would be, it would force everyone into a mode of creativity, efficiency-seeking, market demand that would provide innumerable long-run opportunities.  It would teach valuable lessons in management, as well as a more moral and sound approach to counting ones blessings, budgeting, evaluating needs versus wants, and so forth.    Would it suck for a while?  Absolutely.  And as a father of seven, I don’t remark about this possibility lightly.  But much fruit would come from it, eventually.

Many people point to the Great Depression and the government intervention of the time as a good thing.   Some was, some wasn’t.  It’s been analyzed that many of the governmental programs to help ease the pain of the Depression actually lengthened it.   For my money, give me short and severe, rather than a prolonged event. 

But when the government starts dictating to private industry what kind of incentives to give to employees or brokers, what kind of compensation to pay executives, and what kind of cars to build, this is a recipe for socialism.   It creates a situation where the company who needs to be successful in order to pay back the loan is now competitively hampered.  This, ironically, hurts its business in the long run.

Let’s take the AIG spa “boondoggle,” for example.  While there are plenty of reasons to question management decisions in many areas, this event was not one of them.  But this really struck a chord with people who apparently just don’t understand producer incentives.   This was planned well in advance, and it was a reward for top producers.  Those producers added huge value to the company in terms of premiums and margin.  Many of them likely pushed themselves to sell more precisely because of this incentive.  Was it lavish?   Sure it was.  Was it appropriate?  Absolutely.  It was a promise of compensation in the form of the retreat.  It was not an executive celebration of getting tax dollars.    Now, AIG is scared to death to do anything that gets itself in the news.  So there won’t be these kinds of incentives available anymore while they owe the government money.  What does that do?  It puts AIG in a less competitive position.   For crying out loud, the government should be encouraging the company to do whatever is necessary to be competitive and succeed so that the money can get paid back.  Putting barriers up in the competitive environment only reduces the chance of AIG to succeed.   I can tell you that the company feels obliged to cut certain parties and benefits that other companies don’t feel obliged to cut.  This could affect employee morale and performance.  There are reasons why companies do these things.  They are trying to not only attract customers, but quality employees.

As for executive pay, when the government gets involved and decides to limit compensation, many of us who make a mere pittance compared to these guys may feel a sense of justice.  This may be human nature, but it doesn’t make any sense.   Now, I’m not saying that every guy making millions is doing a good enough job to deserve those millions, but when the value isn’t there, the market will let the company know about it.  Stock price will go down if there is perceived issues with management, and eventually he is replaced.  OK, so it may seem unfair that a guy gets canned with a multi-million dollar severance deal, but how else are companies to compete for the best management professionals?   Right or wrong, letting the companies sort all this out in conjunction with the market response will be the best way to determine the proper market value.   And people like to get all huffed up when this millionaire lays people off.   OK, that’s an understandable emotional response, but sometimes layoffs are the best management decision to make to ensure survival of the company.  You need someone with good business sense and savvy to know which people to keep and which operations to keep running.  You need someone with the vision to know that 500 layoffs today may translate into 2000 new jobs in 3 years if all goes as planned.   This millionaire is being paid to make the tough call, and it may well be argued that his or her salary is best earned precisely when the tough decisions are needed.  This is especially true when the response is due to factors outside the company’s control, and a swift response is needed.

Don’t get me wrong, I am not a hatchet-man.  Just the opposite, in fact.  I believe that you should try your best to keep good people.  Shift them into different positions during “times of war” so that you can best prepare for peace.  Do unconventional things to give a market advantage where you can, and all that.  But there is a cold, harsh reality that can eventually become clear, and in those times we often incorrectly believe that executives are heartless millionaires who don’t care and don’t deserve to be paid.

And perhaps the largest hindrance to the competitive market I am seeing is in the discussion of the auto bailout.  Rather than Congress recognizing that there are competitive disadvantages in worker salaries and benefits that companies are obligated to pay, and rather than relaxing fuel efficiency standards so that auto manufacturers can make more cars that people actually want to buy, the government – in its collective wisdom – wants to tie into any bailout certain anti-competitive clauses aboout what kinds of cars the automakers can make.   Rather than let consumer demand dictate what cars to produce, the government wants to dictate production to force consumers to buy something they don’t want.  The problem with this is that it won’t work, because there are other companies that won’t get bailout money and will produce what customers actually want to drive.

The list could go on.   I haven’t even talked about banks being forced to extend a line of credit on a company about to go bankrupt because the government wants the bank to pay for the company’s contractual promises to union employees.   This, despite the fact that the bank would have no reasonable expectation of ever seeing the money paid back.  So, I guess the solution to the credit crisis is to extend a line of credit to a customer who has no business getting a line of credit extension.   Our government at work, ladies and gentlemen.

All this adds up to serious competitive problems for any business that gets government funds.  The cure for the disease is a low, agonizing, death rather than an instantaneous collapse.   The result is a growing list of businesses that cannot compete in the marketplace.  This will leave us with a choice, eventually: (1) let it fail, or (2) nationalize the company because it’s too big to fail.

As I see things happening right now, the government has decided that all these companies are “too big to fail.”  If the government continues to hold that view when the bailed out companies continue to struggle, the government may take ownership altogether.   This last round got very close to that, and in fact there is a claim on up to 80% of AIG’s stock after 2 years.   Presumably, this would be sold off to private investors.  We’ll see about that.  And when government ownership takes hold of even a few companies, watch out.   The government-run companies will be inefficient because there will be political agendas to them.   They will be anti-competitive.  Soon, more regulations will be passed to put these companies on “an even playing field” with the more innovative, market-oriented privately held companies.  And it won’t be long after all this that the whole system just stops pretending that it’s a capitalistic society and go into a full mode of nationalism and socialism.  We will then get the cradle-to-grave government health care program and numerous other public programs because they will now be government-sponsored health benefits through the companies.  It probably wouldn’t even be a legislative action at that point.

And the best part is, the American people will let it all happen, because nobody wants to go through the pain of a few years of economic turmoil.  We will look to the government to solve our problems rather than relying on the perseverance and creativity we always have relied on.

Now, as a final note, I actually believe that the bailout could have been a net positive.   Had the funds been viewed as an investment from a party interested in the company pursuing market-driven means; had there been no strings attached; had there been a relaxing of regulations to free up business for the pursuit of market-driven opportunities so that the government could recognize that this was the best way of ever seeing their money again…   had this approach truly and honestly been taken, then maybe the infusion of cash could have been good for the market, for taxpayers, and for the companies.   Of course, this was never going to happen.

And so here we are.  Watching the big strong guy toss water out of the boat with his bucket.

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2 Responses to “Why All the Bailouts Will Ruin Capitalism and Move us Into Socialism”

  1. Jeff Id said

    It’s a slippery slope for sure and we have stepped on it.

    What do you think about the decision of our government to buy Freddie Fannie stock instead of mortgages. I don’t have your experience but it seems to me that buying the mortgages, as originally proposed, would have resulted in a potential for payback and improved the quality of the stock in FF from an asset/debt perspective and resulted in the public keeping their own investments in the companies stock. Paulson choosing to invest in stock seemed like a leap down the slope.

    If I’m right there was a serious back door deal in the works. Stock purchase IMO guarantees government support down the road.

  2. The Diatribe Guy said

    Jeff, I have mixed feelings about which course would have been better. My preferred option is “neither.”

    Personally, I don’t see all that much of a difference between the two. In the one case, a company is now owned, at least in pat, by the government. This has nationalization written all over it. However, government ownership of mortgages now means that the government has essentially has an ownership claim on private property. FNM & FRE have a very substantial portion of the market.

    Either way, it’s a jump down the slope. One may get us to the bottom faster than the other, but both are taking us to the same place.

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