Rarely do I get a chance to “scratch my itch” and talk much on economic or political issues. However, I’ve been itching to post a few comments on the present economic situation so here is me scratching my itch…
When the $700 billion (does anyone really know how much money that is?) bailout of the credit markets was proposed in early October, I was a hesitant proponent. (How is that for a firm “maybe”?) I was hesitant because I am by nature very skeptical of the benefits of government intervention but I was OK with the idea as it was initially proposed. The initial proposal was explained by Treasury Secretary Henry Paulson as the purchase by the government of poor quality and foreclosed secondary market debt in order to free up capital for lending and the normal health of the economy.
That situation has changed as the government, politicians, business and labor leaders, and special interest groups are lobbying hard for all kinds of bailouts from large insurance companies, banks and the Big-Three (including my Alma Mater: Ford) to direct subsidies for student loans, car loans and rental property.
I have a simple answer to these types of bailout requests. The answer is “no”.
My response has nothing to do with whether some of these corporate leaders were greedy (of course they were) or whether some people may end up unemployed (also unfortunate but likely) or whether the government has the money to help (it does not). My reasoning is actually much simpler than that and it’s based on the economic concept called “moral hazard”.
In economic terms, “moral hazard” refers to the long-term consequences of bailouts. Bailouts change how organizations handle risk, particularly the risk of failure. In simple language, when governments bail out people or organizations, it makes them and other people and organizations actually change their behavior not for the better but for the worse as bailouts actually encourage them to manage and make decisions that are more risky and more likely to require another bailout in the future.
Intuitively, we know that when we continue to make excuses or come to our children’s rescue, it encourage more of the same unfortunate behavior. Many of us have known for years that one of the downsides of pumping more money into programs that provide safety nets to people also encourages more people to behave in ways that make them more likely to require safety nets.
If we are fortunate, this economic downturn will not be severe enough to punish organizations that have been diligent enough to be re-engineering, reinventing and re-marketing themselves and are truly competitive in the world market. If the economic downturn is very severe and/or companies have been fat and happy and have not been diligent to remain competitive, the bailout won’t help them anyway.
