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Brooks Wilson's Economics Blog: A Cautionary Tale of Bailing Out Equity

Friday, January 2, 2009

A Cautionary Tale of Bailing Out Equity

This post is dated; it should have been written in September or early October. On October 1, Paul Krugman made a prescient remark on the government bailout,

My view, which I think is now shared by many economists, is that Paulson grabbed hold of the wrong end of the stick — he should have been seeking to expand bank capital, taking an ownership share in compensation, rather than trying to push up the value of toxic paper. In the end, that’s what we’ll probably do.

Later, Krugman criticized the Bush administration for taking equity but not protecting taxpayers by voting rights or negotiating other concessions from banks and investment banks.

On October 5, Don the swing voter from the Daily Kos succinctly stated his plan,

Nationalize. Then privatize. That is a proven approach.

I am in a fortunate position. I can sit back and criticize without making a decision. I do agree with Don, if you are going to buy equity, nationalizing or partially nationalizing, get in and out as quickly as possible. Long ago, in economic circumstances far, far away, Boarding and Vining studied the performance of private firms, state-owned enterprises, and mixed firms. Mixed firms have both private and government ownership. They found that

The results provide evidence that after controlling for a wide variety of factors, large industrial mixed enterprises and state-owned enterprises perform substantially worse than similar private companies.

While banks, investment banks, and insurance companies are not industrial companies, the incentives faced by private companies, nationalized companies and partially nationalized companies differ. Private companies will try to maximize profits while minimizing costs.

State-owned companies may try to increase employment, increase worker pay, introduce what they consider socially beneficial products, or not introduce innovative products.

Many mixed firms have the worst characteristics of both private firms and state-owned firms. Like Fannie and Freddie, profits may be private and losses paid by taxpayers, or they maintain inefficient social policies to satisfy government overseers.

2 comments:

  1. "Nationalize. Then privatize. That is a proven approach."

    The idea sounds good to me. After all, the private sector certainly knows more about how to expand their profits (which ends up benefiting the nation). Nevertheless, it is a known fact that private companies, in their status as a business that is owned by a few number of people, will only seek to find their own wealth.

    Even when the economy is "doing bad," they will always attempt to keep the same profits they have been making by doing things such as firing workers (which in the long-run creates even more problems for both society and the economy), placing their business in other countries and taking them away from the U.S., and other silly things that would not happen if these people actually cared about the country.

    I believe that the government should do what is best for its people. Private businesses only care about themselves, their income, and not about the economy of the whole nation. Sure, the private businesses have always been the driving force of the economy, but that is just a lucky side-effect for us. Setting it in microeconomic terms, this can compare to those companies who make video games just for the profit, but the side-effects the video game creates on the people is none of their business.

    Of course, the government is no saint. Even if they come down with their mighty flaming sword and rid us of the evil private businesses, the fact remains that it is the evil private business that puts more money in our pockets.

    Basically, as the quote of Don says, the government should just get in, get things back on track, and give it back to the "players" of this daily game of Monopoly.

    However, this is always easier said than done.

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  2. My comment to the blog is that The idea of nationalizing then privatizing sounds rational but wouldn't it be better to go ahead and privatize and allow specialized individuals to capitalize on the bailout of equity. I guess it might just be better to stick with what you know has proven to be effective and take no risk

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