I’ve participated in White House conference calls on a number of issues in recent years. While I have not always agreed with President Bush’s position, my views have always been treated with respect. Recently I participated in a conference call to discuss the ‘President’s Announcements on Auto Loans’. When I expressed opposition to this bailout of auto firms, my views were summarily dismissed, and I was cut off so that other participants sympathetic to the President’s plan could speak. President-elect Obama claims that only one ‘outside’ economist has expressed opposition to the stimulus plan and bailouts.
It’s important to set the record straight on opposition to the stimulus plan and bailouts. I am not alone in my views, I spoke with more than a dozen economists attending a recent meeting of the American Legislative Exchange Council who oppose the stimulus plan.
The fatal flaw in the bailout plan for the auto industry and in the stimulus plan in general is moral hazard. Auto executives now have an incentive to wait for taxpayers to cover their losses. Without the bailout money the auto firms could enter bankruptcy. Those who support the bailout argue that bankruptcy would create too much uncertainty for the auto industry, with negative consequences for the broader economy. In fact, bankruptcy provides a clear rule of law for restructuring these firms, reflecting market realities. The losses incurred by the auto firms would be borne by investors, managers, and workers in these firm, just as they are when other firms enter bankruptcy.
It is not clear that the auto firms can avoid bankruptcy, even with the bailout money. However, the bailout creates additional uncertainty, and shifts losses to taxpayers. The conditions the President has imposed as part of the bailout are not worth the paper on which they are written, because the incoming administration will impose their own conditions reflecting their political interests. Meanwhile auto manufacturers have an incentive to sign on to the bailout plan because it promises a better outcome than one that would result from bankruptcy proceedings. The initial bailout of auto firms is likely to be a down payment on a larger stream public subsidy to these firms at taxpayer’s expense. If conditions imposed on the bailout by the Bush administration are too onerous, auto firms can always renegotiate those conditions with the Obama administration.
In short, what the President has offered to the auto industry is a blank check, with taxpayers picking up the tab. This expenditure of taxpayer dollars for corporate welfare has not been lost on other interest groups. In fact, it has set off a feeding frenzy in which other interest groups are now scrambling to the public trough.
State governors are now asking the federal government for bailout money to offset shortfalls in state revenues. Governor Rick Perry of Texas and Governor Mark Sanford of South Carolina have responded with the obvious question. Why should the citizens of our state, which has balanced the state budget and pursued prudent fiscal policies, be asked to bail out states such as California and New York that have pursued imprudent fiscal polices accumulating tens of billions of dollars in debt?
A coalition of state university presidents is now lobbying congress to use bailout money to offset shortfalls in university budgets. Heads of private colleges and universities that receive little in the way of public funds, are asking the obvious question. If we are forced to cut budgets and trim programs, why shouldn’t public universities do the same?
A growing list of financial institutions has now lined up for bailout money. Citizens who are paying their mortgage, credit card, and other debt are asking the obvious question.
If we have been prudent in budgeting our hard earned money and paying our debts, why should we pay taxes to bail out people who spent money and incurred debt that they couldn’t afford?
What President Bush and President-elect Obama fail to understand is the difference between policies to provide liquidity in financial markets, and policies to prop up insolvent financial institutions. The solution to the current financial crises does not depend upon bailouts; financial markets will be on a sound footing only when insolvent financial institutions are restructured. The precedent for this solution to the financial crises is in the Resolution Trust Corporation established to restructure savings and loan institutions in that financial crises. Insolvent savings and loan institutions were restructured; while increased liquidity was extended to solvent institutions. The moral hazard created when insolvent institutions are propped up with bailout money only exacerbates and prolongs a financial crises.
What President Bush and President-elect Obama need to say to auto executives, state governors, university presidents, bankers, and other lobbyists for bailout money is the advice my swimming coach gave me when I was struggling. ‘SUCK IT UP’.
Barry Poulson is a professor of economics at the University of Colorado and a fiscal policy analyst for the Independence Institute.