Almost all rules have exceptions. This is true because the real
world is a complex place, more complex than theory often allows.
And this is why, to quote Emerson, “A foolish consistency is the
hobgoblin of little minds, adored by little statesmen and
philosophers and divines.” Campaigning in Michigan, Rick Santorum
has sought to bolster his conservative bona fides, declaring his
own ideological consistency in opposing government “bailout” plans
for both the automakers and of “Wall Street,” and contrasting that
to the “inconsistency” of his rival, Mitt Romney, who opposed the
auto “bailout” but supported the Troubled Asset Relief Program
(TARP), portrayed by Santorum as a bailout for Wall Street and the
big banks. In failing to understand the difference between TARP and
the auto bailout, Senator Santorum betrays a foolish
consistency.
All American conservatives, myself included, disdain
government meddling in the private sector. From a practical
perspective, it is usually counterproductive and wasteful
(Solyndra, for example). From an ideological perspective, it is
rarely justified as a necessary and legitimate application of
government power, and is almost always a dangerous precedent,
inviting ever more and greater infringements on personal liberty
and the workings of a free market. But this does not mean that
government intervention is never, ever an appropriate
option.
The Obama administration’s auto bailout plan that both
Senator Santorum and Governor Romney rightly opposed is clearly an
example of unjustified, dangerous, and (despite all the hoopla from
the media regarding its supposed “success”) counterproductive and
wasteful government action. Proponents of the plan argue that
without the government bailout, tens of thousands of GM and
Chrysler workers would have lost their jobs, and thousands more
employed by suppliers to the automakers would have lost theirs,
too. Instead, all these jobs were saved, GM is now profitable, and
the cost to taxpayers is minimal. The problem with this
justification is that it is wrong on every point. The government
bailout did not prevent GM and Chrysler from going into bankruptcy.
And just as if they had gone into bankruptcy without the government
plan, GM and Chrysler continued to operate while they reorganized.
The essence of the bailout plan was not “saving jobs” or a portion
of the dwindling U.S. manufacturing base, but rather paying off a
Democratic constituency, big labor, by forcing a pre-bankruptcy
deal whereby the holders of senior debt had their legal positions
stripped from them so as to hand whatever value remained over to
the UAW and the UAW’s pension plan. Chrysler got over $10 billion
in taxpayer assistance, was taken over by Fiat, who somehow then
got a $3.5 billion loan from the U.S. Department of Energy. The
Obama administration gave GM $60 billion in taxpayer cash — $10
billion in a loan and $50 billion as an equity stake (at a highly
inflated value) — plus another $15 billion in tax benefits. GM has
since paid back the $10 billion loan. Hurray. For taxpayers to be
made whole on their equity investment, the price of GM stock will
need to double.
So how much did the auto bailout cost? It’s hard to say.
The White House estimate is $14 billion, the CBO estimates $20
billion, but it could be $40 billion. And the benefit? According to
Paul Roderick Gregory of the Hoover Institution, perhaps 4,000 auto
related jobs more than what would have resulted from a traditional
bankruptcy program. GM and Chrysler would still be around in
reconstituted form. And the overriding imperative that demanded
government intervention? Nothing more than coming to the aid of a
narrow political constituency.
Is Rick Santorum right in portraying the TARP program for
Wall Street and the banks as no different than the bailouts of GM
and Chrysler?
Unlike the auto industry, the financial industry directly
impacts almost every meaningful business enterprise in the country
as almost every meaningful business relies on credit for its own
operations or on the credit supplied to its customers. Whereas the
auto industry bailout supporters argued about the ripple effect
that auto plant closures would have had on the relatively small
universe of auto parts suppliers, the finance industry is a
supplier of a key component to almost every other industry in the
country. As an old accounting professor of mine once put it, money
and credit is the blood of the economy. You may be a great guy, but
without blood, you’re in some serious trouble. And that’s exactly
where the U.S. economy was at the onset of the financial collapse
in the fall of 2008.
Everyone knows about bad real estate loans, securitized
into pools sold off to investors as “AAA” credit investments,
insured by giants like AIG (with pitifully low reserves), all of
which came crashing down as the real estate market cooled and
debtors in way over their heads, with no way of refinancing started
to default left and right. All of a sudden banks and other
financial institutions discovered that large portions of their
balance sheets were made up of securitizations of unknown but
dubious value, trading in some cases at 30 or 40 cents on the
dollar at fire sales at distressed financial institutions, and due
to “mark-to-market” accounting regulations they had to start taking
massive write downs of their assets, putting their capital ratios
out of whack (indeed making some institutions insolvent), resulting
in not only a stoppage of lending, but the need to shrink the
amount of outstanding loans (a process known as deleveraging),
effectively reducing the money supply.
Less known, and what really spurred the Federal Reserve,
the Treasury Department, and Congress to dramatic action, was what
happened in the commercial paper market in the wake of the Lehman
Brothers collapse in September 2008. Lehman was a big supplier of
corporate paper (short-term loans to commercial borrowers for
everything from working capital for inventory to gap lending to
meet payroll when collections of accounts receivable are slow),
which in turn is one of the primary assets in which money market
funds invest. After the Lehman collapse, for the first time ever,
people lost money in money market funds, which were supposed to be
a “safe haven.” A panic ensued, the electronic equivalent of a run
on banks. Within days, the money market funds were hit with
redemptions of $500 billion — more than 25% of the market. As a
result, for a few weeks there was almost no available supply for
short term commercial paper. The market was frozen. Market theory
suggests that as interest rates rose to try to attract capital,
equilibrium would be achieved. But with panic keeping money on the
sidelines, it is difficult to say just how long financial markets
would have been frozen and just how long the U.S. economy would
have been deprived of its blood. Without credible action by the Fed
(supported by the Treasury) to end the panic, the damage to the
economy could have been considerably worse than it was. Panic
begets panic, and failing financial institutions take down other,
healthier institutions, with them as the financial industry is
based on leverage.
Yes, the U.S. economy has survived financial panics before
(recessions and depression used to be called “panics” precisely due
to their source). But all indications were that 2008 could have
been as bad as anything we had ever seen. As Milton Friedman
chronicled, the Great Depression was in large part the result of a
similar collapse in the money supply, as the Federal Reserve failed
to stop the domino effect as bank after bank failed. In 2008, the
Fed took dramatic action and stopped the panic. The deleveraging
process continued, and will likely continue for a while, but in a
more orderly and less destructive fashion. TARP was initially
envisioned as a way to buy up “toxic assets” to get them off of
banks’ books so that banks could start lending again with cleaner
balance sheets (and the Fed possibly making money selling the
assets, bought at a deep discount, as conditions improved). A big
part of the plan, however, quickly turned into massive capital
infusions into the banking system in the form of purchases of
preferred stock. Since time was of the essence, this was seen as
the quickest way to stabilize the financial industry rather than to
figure out the complexities of buying and selling asset
pools.
Such direct investment in U.S. companies was nearly
unprecedented, and certainly scary, though not as scary as the
wholesale nationalization of banks that many were advocating.
Calming the markets, and even taking over unhealthy financial
institutions, is clearly within the role of the Federal Reserve,
but the massive interventions, including equity investments, of
2008 and 2009 were pushing the envelope. In the end, most of the
direct “bailout” aid was repaid, with interest. Though it is
tangled given that much of the auto bailout was allocated through
TARP, the numbers are that of the original $700 billion authorized
for TARP by Congress, $414 million was disbursed, $124 billion
remained outstanding at the end of 2011, and the CBO estimates
losses will be $14 billion, exclusive of auto bailout losses.
(Though not a part of the TARP program, the Federal Reserve does
currently hold $850 billion of Fannie Mae, Freddie Mac, and Ginnie
Mae mortgage backed securities, which could be a source of future
losses, but those mortgages already carried at least an implicit
government guarantee.)
Did the situation justify such action? It is a reasonable
point of debate. Certainly the specifics of some of the actions
taken were questionable (as is almost always the case with
government actions). But in the final analysis there wasn’t much of
an alternative to some form of aggressive action by the Federal
Reserve and the U.S. government constituting some sort of
“bailout.” The unique nature of the financial industry makes its
rescue different in kind from the bailout of the auto industry.
That may not satisfy an ideological purist, but whereas ideology
can point you in the right direction, in a complex world it can
also be a straightjacket if you let it, and sometimes ideological
consistency can, indeed, be foolish.
