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Our government has been doing its share of bailouts in the last year. It put $29 billion of taxpayer money at risk to finance the takeover of Bear Stearns. It stands ready to use $800 billion to bailout Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). And now General Motors (NYSE: GM) wants $50 billion in government guarantees to finance fuel efficient cars. I have been looking into the bailout issue and whether it is beneficial or a misuse of funds - and there is a lot of debate about this issue. These bailouts may make political sense but are they in the long-term economic interests of the country?
A colleague of mine who was a Budget and Cost Analyst for a top government agency has been thinking about the political aspect of bailouts and shared his thoughts with me. As he wrote, "It is a sure thing that either party could get votes from a bailout, but they might loose some as well. Where a party could really improve its position would be to support a bailout, but lose."
He suggests that this outcome would pay off in the short-run but could damage long-term economic outcomes. As he suggested, If the party supported a bailout but lost, "it could claim that it was trying to support the victims, but had been frustrated by the other party. And this could be used to promote the party for many years in efforts to get votes. While maneuvers of this sort may get short run votes, over the long term they might be hurtful of sound economic growth and performance."
My colleague suggested that not all bailouts are bad -- there are times in history when bailouts are truly necessary for society's survival. As he wrote, "Of course, there are situations where the whole society needs a bailout, such as in the Great Depression when many government agencies, such as the Reconstruction Finance Corporation (RFC), were formed to alleviate the terrible economic problems." The RFC spent $20 billion back in 1932 -- $321 billion in 2008 dollars.
He pointed out that such situations are not ancient history. The S&L problem in the late 1980s prompted such a bailout. As he suggested, "A reconstruction agency -- the Resolution Trust Corporation -- was formed in 1989 to buy up failed banks, so this approach is still with us. I guess that when a problem is big enough the government will always step in and this is political because it would be criticized if it did not. Where to draw the line in the size of a bailout seems to be a key issue."
My colleague was pondering how government financial management might be changed to avoid subsuming long-term economic considerations to short-term political interests. He suggested that long-term infrastructure investments should be financed and budgeted differently than ongoing government operations. In his view, the infrastructure projects should be financed with debt and the annual operating budget would be paid for out of taxes and fees.
As he wrote, "I have always thought that our government should be financed and accounted for in a different way. We should have a capital budget which finances infrastructure investments - bridges, dams, roads, buildings, computer systems, weapons systems, perhaps government R&D, etc."
What was his logic for this? He suggested, "These are all things with long lives that are needed for sound and safe economic growth. It would be prudent to finance these things with debt, perhaps 75% debt, because the economic gains from the improvements would help pay off the debt over time."
He thought that the government's annual operations should be paid for in a different way. As he said, "Then, there should be an operating budget which covers the costs to operate the government, which includes all of the current costs for everything from salaries, energy, travel, supplies, etc. These costs would not be financed with debt and would be met from annual inflows from taxes, fees, etc. Thus, the annual budget would include all operating costs and the current year costs of financing the capital investments."
He believes that this approach would make for a more transparent economic debate. As he put it, "With this approach it would be possible to control debt and use it wisely to improve the country and our economy. If a bailout is needed, debt would be required (by definition) and there could be an informed debate regarding whether the problem is so severe that additional debt is required. Thus, it would be aboveboard and out in the open as a major issue to be resolved."
This approach makes sense to me. What do you think?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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Reader Comments (Page 1 of 1)
9-01-2008 @ 10:52AM
stlboxmaker said...
Bailouts= Welfare, welfare has never done anything except keep people from gathering the effort to help themselves. I am not talking about people who are really sick, or old and have nothing left except outside help; but we are probably talking about about 20-30% of the people actually drawing it.
The people who got 4% loans and they went to 9% or higher new this going in the Mortgage companies new this also. "Dumb + Dumb / I Want It No Matter What - Ignorance.
If the govenment is bailing people out it should start at paying the poorest persons mortgage and right up to the largest billionares. Bailing these people out is as dumb as bailing out Chrysler back in the 70s. Our govenment and most of out people have gone crazy when it comes to finances. If you sign a contract you are obligated it is not up to someone esle to bail you out.
9-01-2008 @ 12:18PM
whtm said...
stlbox ! DO YOUR HOMEWORK ! THE CHRYSLER BAILOUT YOU TALK ABOUT WERE LOAN GUARANTEE's NOT A BAILOUT ! LIKE WALL STREET BANKS ? NOW THATS A WELFARE BAILOUT ! EVERY PENNIE WAS PAID ... I REPETE PAID BACK ! BANKS HAVE NO MONEY TODAY FROM THEIR MIS MANAGMENT ! GIVING MORTGAGE's WITH NO EMPLOYMENT CKs NO CREDIT CKs NO WONDER THEY ARE NOT OUT LENDING MONEY ! THEY DON'T HAVE ANY !! BUT WHEN BANKS AND WALL STREET LOSES MONEY lol THEY CALL THAT A WRITEDOWN ? OR A CORRECTION? WALL STREET CODE WORDS FOR A LOSS!!!! lol lol YA ANOTHER RUSHBOT AMERICAN ? FOX NEWS MUST BE YOUR ONLY INFO... lol lol ..
9-02-2008 @ 3:05AM
Jon Kepler said...
Wow, didn't know people still left caps lock on.
Anyway, I'm more or less anti-bailout, however they do help to rid the market of panic as people embrace the "our government will take care of us" mentality. If it was widely announced that there were going to be no bailouts anywhere no matter what, you'd have to wonder where the market would be right now.
9-02-2008 @ 3:40AM
gumbo koontz said...
GM and Ford sank to historic lows simply because short sellers naked or not are still stickiing to their guns and insisting that GM and Ford keep on falling to zero . Mutual funds hold the majority of GM and Ford stock and they are not complaining, duh? Once the government bail GM and Ford, the short seller will be forced to cover their shorts and prices will go up again. GM and Ford is still heavily held by mutual funds and institutions. GM and Ford stock is at century lows...
9-02-2008 @ 3:47AM
gumbo koontz said...
You can compare it to the last days of horse and buggy... You see, our cars had been designed to idle when not moving. Gasoline was cheap back then and no thoughts were given to the wasting nature of idling engine while stopping at intersections or creeping bumper to bumper in rush hour traffic. GM and Ford is now in a major transformation in order to produce cars that no longer use any energy while stopping at intersections and bumper to bumper traffic. That is why we are starting to see words like hybrids, etc. Chevy Volts, among others that will strive to waste not another drop of gasoline. If anyone doesnt think GM and Ford deserves a bail out, he generally doesnt understand what is going on.
9-02-2008 @ 3:53AM
gumbo koontz said...
If my explanation for the bailout of GM and Ford as stated above is fairly correct, then $50 billion is a bargain as far as combatting global warming is concerned. What better place to be in besides the automotive business which is a major source of global warming. After years of regulating exhaust emissions, we still find more ways to continuing doing that by transforming GM and Ford with a bailout that they deserve. Maybe $100 billion because GM and Ford combined is responsible for over $400 billion in annual GDP not counting part suppliers and beyond.