Friday, September 19, 2008

Bailouts, Bailouts Everywhere…

…but not a drop of common sense in D.C.

Unbelievable. Apparently my fantasy that Ben Bernanke reads my blog was shot to smithereens. Only a day after I praise the decision to pass on a bailout of Lehman Brothers, they decide to go ahead and make you and me the proud owners of a poorly run insurance company. Why? Because it is "too big to fail". In the latest fiasco, the federal government (that's the you and me part) paid <Dr. Evil voice> 80 BEEEELION DOOOLLARSSS </Dr. Evil voice> for an 80% stake in AIG. The company will finally live up to its name…American International Group. That's the only funny thing I can find in it.

The argument that something is too big to fail is compelling on the surface. It is logical to assume that if AIG were to close shop, there would be many external effects on the economy. Others who rely on AIG would have to find alternatives, and in many cases it may cost them their financial well being. This is unfortunate and a byproduct of not allowing the markets to correct themselves in a timely manner. There is a fundamental concept in economics that there is no such thing as a free lunch. What this means is that everything comes with a cost. If the government is giving money to one person, they have to take it from another. It seems free to the recipient, but in reality, it is not. If we artificially prop up a business that is not able to make it on its own, it comes at a cost to those that have to put up the money. Again, that is us. So instead of the people involved with the failing business paying the cost, like the shareholders and management, it is shifted to those of us that have nothing to do with it. This is always the case with a bailout.

This would be bad enough if it stopped there, but like a good infomercial…wait, there's more! When a person or business is not held accountable for their bad behavior, but instead are made whole at the expense of others, it only encourages more of the behavior that got them into the problem in the first place. These financial companies made bad investment decisions by not properly accounting for the risk of those investments. Now, these are professionals, many with vaunted Ivy League credentials, and were certainly taught risk management at those places. So why would they do that? Because they know that if it all goes bad, the government will be there to make it better because they are "too big to fail." By bailing out these firms in order to prevent the negative consequences of their actions on the economy, the government is actually creating more strain because they allow bad firms to keep running, and encourage others to take on too much risk.

Another example that may help in understanding this is government subsidized hurricane insurance. No one wants someone else to lose their home in a hurricane, but should other people pay to replace that person's home? Is there no accountability for deciding to live in a place with a high risk of getting hit by a hurricane? It is very expensive to buy hurricane insurance. Why? If you live on the Gulf Coast, there is an extremely high likelihood that your property will have to survive a hurricane at some point during your ownership of it. The risk to an insurance company is very high and so the resulting premiums, set by the free market competition between insurance companies, are high. The government wants to "help" people by paying for part of the insurance cost. So when a hurricane comes, the home owner gets reimbursed by other taxpayers, most of whom chose a more responsible place to live. They then rebuild their house, in the same risky place, never learning the lesson that should have been learned.

It is fundamentally unfair to force you and me to pay for the folly of others. It is no different whether it is hurricane insurance or AIG or Countrywide or Lehman. The losses should be borne by those responsible for them. This is the only way that foolish behavior can be cut out of the marketplace. When you touch a stove and somebody else gets burned, you will keep touching the stove. That is, until those getting burned start picking up pitchforks and march on your kitchen…


 

6 comments:

Dennis D. said...

Initially I was leaning toward agreeing with you on these points, but then I says to myself, "self, if we do things like that then how will Obama's top advisor be able to make all that extra cash?! If we don't bailout AIG, then the next thing you'll say is that Freddie Mac and Fannie Mae aren't supposed to allow themselves to be so short on liquid capital on hand." That is simply madness.

el norteno said...

Kirk, I see that Hank Greenberg was the head of AIG. Isn't that the same guy that ran Green Tree Acceptance? Shouldn't he be in jail?

Kirk said...

Hank hasn't been in charge of AIG since 2005. Elliot Spitzer did bring fraud charges but they were later dropped. Hank claims he did nothing wrong but I do not know all of that story. I googled Green Tree Acceptance and Hank Greenberg and didn't find anything, so I am not sure on that part.

All I know is that AIG was better run under Greenberg than the current management.

Tam said...

That is exactly what I said when I heard of the AIG bailout. Good thing you grew up around me!

el norteno said...

AIG? Kid stuff. $80 Billion? Chicken feed. Let's go all out!

Danny said...

Do not Bail them out! I wish they would just let it go and say "learn to swim". Me and my family will always have food and shelter, so i say screw em. Even let the economy go crash it will come back up someday. In the meantime my wife and I will have a full time job fishing and making a wood cabin, i got ideas for electricity of the grid also. So we good.