Tuesday, November 11, 2008

Corporate Bailouts: Will They Prolong a Recession?

I’m sure I’m not the only taxpayer frustrated by Washington’s generosity to irresponsible, politically connected corporations. We hear that the credit markets are frozen. Without federal dollars, America would see a domino effect of banks failing one after the other. If you believe this, I have some land I’d like to sell you. Look through your “junk mail,” both snail and online, and see how many invites you receive for credit. Take a stroll to your local car dealership this weekend and see how quickly they’ll get you financed. While it may be true that people who have less than appealing credit or are overextended may not be getting offers, but is that a bad thing? Aren’t reckless loans what got us here in the first place? Isn’t it natural for banks to hold back on lending in harsh economic times? What is the demand for borrowing when people are afraid of losing their jobs?

President Bush’s $168 billion economic stimulus plan in February of this year was supposed to give the economy the boost it needed. Then, along came Bear Stearns. The federal government extended a discounted loan to JP Morgan Chase to entice them to buy Bear’s troubled liabilities. Case closed – economy saved…hardly. In October, the market began to hemorrhage. State governments are now asking for federal dollars along with the troubled auto industry. President Bush addressed the nation assuring us that the federal government would rescue the falling economy. The government being the rescuer is the equivalent of a small raft being thrown to someone drowning in the ocean in the middle of a hurricane, when the one throwing the raft was the cause of the storm!

The federal government now has plans to take stakes in nine of America’s top financial institutions and equity investments in potentially thousands of other banks. One month later, the DOW continues to plunge, consumer confidence is in the tank and the threat of more foreclosures still exists. The threat of a global recession is eminent. What does our President-elect say? More economic stimulus is needed! Why not, as it has worked so well thus far. Don’t forget; he was hired to fix the economy!

One only needs to take a look at history to see how well government intervention works. Did President Hoover’s Reconstruction Finance Corporation of 1931 and 1932 end the Great Depression? Hoover gave federal loans to politically connected companies much like the Paulson/Bush plan. When President Roosevelt took over, he invested heavily in the country’s infrastructure and took the Keynesian approach. Both of these approaches turned a bad recession into the Great Depression and further prolonged misery.

Critics of capitalism and a laissez-faire approach fail to realize that economic downturns are part of the overall economic cycle. Recessions do not mean that capitalism has failed. That also doesn't mean that government oversight is not needed; but there is a difference between proper oversight and intervention. The problem with government intervention is that it prolongs the downturn and creates new problems in the future. Fannie Mae and Freddie Mac were the outgrowth of “The New Deal” along with the waves of entitlement programs that the government is currently having a difficult time funding.

The Bush administration wasn’t interested in bailing out the “dot com” companies at the beginning of this decade. Is the tech sector dead as a result? America had an 8-month recession with a decent recovery. While the credit crisis is far more severe, over-reaction can make a bad situation worse. The federal government has already spent over $1 trillion to try and stop the bleeding. The new administration plans on spending more and possibly a move to bail out the ailing auto industry. As it stands, the federal deficit will exceed $1 trillion next year. The potential effects these actions will have on the value of our dollar and impending inflation, one has to ask if we are pouring water into a leaky bucket and what the opportunity cost will be from allocating an incredible amount of resources to banks, individual states and companies that are poorly run.


SPender said...

It is best to think of a bailout in the manner of these ones, as placing a band-aide on a severed limb. "It's just a flesh wound"...

The problem is that these organizations are wounded within, and failing externally for a reason. If they had something to "bank" on with investors (like Colman Mockler did when fending off a takeover of Gillette) - something to bank on (like new technology), that would make investors confident, than they would not be in as dire of a situation.

The issue is that while these organizations have some R&D, the majority of their finances have been allocated into corporate fiscal sewage (pensions) - things that produce no value, but suck out the life. GM has not been an automotive company for years, it has been a retirement community & A credit company (GMAC).

If these organizations would practice sound business principles and return to making tough decisions to cut areas that are hemoraging, then they would be in a much different circumstance down the road. Plus, investors would have much more confidence in the value being produced in the company.

Michelle S said...

LOL, I almost used that exact analogy! I opted for the water in a leaky bucket instead.

That's exactly it...none of these companies have a sound overall corporate strategy..no product..no reason to invest. Yet, the government can just work magic and money creates a strategy.

Unions are also killing GM along with the rest of their corporate fiscal sewage.