Treasury to Bank of America: You've Got Mail

In December 2008, Merrill Lynch & Co. (ML) was on the verge of bankruptcy.  Bank of America (BA) was the Treasury's last remaining viable buyer.  As the negotiations to acquire ML proceeded, additional information about Merrill's potential losses spooked BA CEO Kenneth Lewis, who suggested to Secretary of Treasury Paulson that they were going to exercise a material adverse clause in the merger agreement to end negotiations.  Paulson and Federal Reserve Chairman Bernanke pressured Lewis to go forward with the deal and he capitulated.  Craig Torres and Scott Lanman of Bloomberg tell the story more fully in, "Fed Memo Said Aid for Bank of America Would ‘Come at a Price’" (June 11, 2009).

Jessica Pressler a New Yorker writer gives sage advise in "Fed Flamed Bank of America CEO in E-mails, Threatened to Have Him Fired" (June 11, 2009).

See, this is why we always say that if you're going to threaten someone you should do it in person, in an area that has been swept clean of recording devices. What is even the point of working for the United States government if you cannot take advantage of the CIA's infrastructure for this stuff? The full e-mails have not been released yet, but we imagine when Bernanke's whole "Don't you know who I AM? You and me, we’re f*****’ DONE professionally" rant hits the Internet he's going to be mighty embarrassed.

The Bush administration professed love for markets until the financial meltdown began in September, 2008, when President Bush proclaimed "I've abandoned free-market principles to save the free-market system."[1]  The negotiations between the Treasury and BA illustrate that the Bush administration was willing to run roughshod over private property rights to obtain its objectives. Motivation for Bernanke's actions may be found in his American Economic Review paper, "Bankruptcy, Liquidity, and Recession, (Vol. 71, No. 2, May 1981).  Bernanke begins his paper,

This paper examines the possibility that the economy-wide level of bankruptcy risk plays a structural role in the propagation of recessions.  The argument is as follows: Bankruptcy imposes net social costs, so that all agents have an interest in avoiding it.  Consumers and firms do this by being careful to retain sufficient liquid assets to meet fixed expenses; banks and other lenders, by being selective in choosing borrowers and limiting the size of loans.  The onset of recession strains the system by reducing the flow of income available to meet current obligations and by increasing uncertainty about future liquidity needs.  There is a general attempt to insure solvency which leads to a reduced demand for consumer and producer durables--which may in turn generate further income reductions. 

Bernanke's confidence in this model as Fed chairman exceeds his confidence as a researcher.  Near the end of the paper, he describes evidence supporting his model.

At present the empirical evidence relevant to the story I have told is limited and does not permit firm conclusions. 

The coerced purchase of ML by BA illustrates the sad nature of political commitment to markets.  Republicans often profess their love of markets in good times, but abandon them as soon as a crisis occurs with little or no evidence that the government will perform better.  Democrats are generally more skeptical of markets, but lack political support for increased intervention in good times.  But when a crisis comes, with religious fervor, Democrats "never let a serious crisis go to waste."  The result is that crisis often results in more government regardless of the party in power as Robert Higgs hypothesized in "Crisis and Leviathan,"   (Oxford University Press 1987).[2]

If anything, the Obama administration has less respect for private decision making than the Bush administration.

[1] Don Boudreaux of Cafe Hayek wrote the "Politicians Principles,"

I wrote the following lines in a private letter to friends back in December when George W. Bush, then still president of the executive branch of the U.S. national government, announced that he was abandoning his free-market principles.  The truth of these lines, however, transcends time and political party.

The man who never cheats on his wife because no other woman will have him is not particularly principled - but he proudly fancies himself that way. So the first bimbo he sniffs who'll do him the honor will prompt him to "abandon his principles" with as much alacrity as a hungry dog will attack a ham. Such are the principles of our "leaders."

(P.S. One cannot abandon what one never possessed.)

[2]  Beginning in the late 1970's and continuing until the 1990's economic crisis induced government officials to deregulate and privatize.  Perhaps Higgs' hypothesis should be amended to read that "crisis causes government action." 
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Who's Running GM?

President Obama said his administration does not want to run the day-to-day operations of GM.  Neil King Jr., Jeffrey McCracken and Mike Spector describe the administration's position ("Potential Conflicts Abound in Government Role," Wall Street Journal, June 1, 2009). 

Once helping a company such as GM restructure, the government would manage its stake "in a hands-off, commercial manner" and not get involved in issuing day-to-day directives to GM, the guidelines said.

Currently, the Treasury plan is to hold its GM ownership stake in a blind trust, say people briefed on the situation, and draw up so-called trust documents that lay out how that trust and its government-appointed trustees will manage the government's majority stake in GM.

The selection of Edward Whitacre Jr. as the new chairman of GM illustrates what the government means by "helping" a company restructure.  Amy Thomson and Katie Merx of Bloomberg describe how Whitacre was selected ("Whitacre Vows to ‘Learn About Cars’ as GM Chairman (Update1)," June 10, 2009)(HT Drudge).  Nowhere does the article mention discussions with the existing GM management or anyone that has had experience in the auto industry. 

“What was required was somebody with savvy, big-business experience that could take a company, change its management culture, make some of those tough decisions to put it on that path toward viability,” Press Secretary Robert Gibbs told reporters at a briefing today.

The U.S. Treasury, which is backing GM’s restructuring with about $65 billion, reached out “some weeks ago,” Whitacre said, enticing him out of retirement to help oversee a company that has lost almost $88 billion since 2004.

“Lots of conversations” followed with Steven Rattner, the Wall Street dealmaker running President Barack Obama’s car task force, said Whitacre, adding that Treasury’s message was: “We need your help. It’s a great company. You could be a lot of assistance to GM.”

Why does the administration need to run the day-to-day operations when it has already decided the basic product and the management team to produce it?  Does anyone really believe the administration can't flex its ownership control anytime that it wishes?  Even if the executive branch manages to turn (10%) control of the company to other owners, the Canadian government (12%), the UAW (17.5%) and former bondholders, could the new owners keep Congress out of business decisions?  King et al write,

Congress also is sure to exert its muscle over GM's affairs, as it did in recent weeks. Key lawmakers rebelled in May when word got out that GM, post-bankruptcy, planned to boost its imports of cars made at GM factories in China.

With pressure building on Capitol Hill, GM agreed as part of its talks with the United Auto Workers to reopen an idled factory in the U.S. for smaller models not now produced domestically.

King, et al also note potential conflicts of interest between regulators and the government owned company.

Some experts already are asking what will happen within the Office of Management and Budget when regulations are promoted on fuel-efficiency standards or safety standards, for instance, that will prove costly to GM, and thus also to the federal government.

"Once the federal government is not simply a regulator, but is all of a sudden also on the receiving end of regulations, that fundamentally alters the politics of how the government interacts with the car industry," said John Graham, an auto safety expert who served as President George W. Bush's regulatory czar within the OMB.

That neutrality issue will be particularly pointed when it comes to Ford Motor Co., which alone among the Big Three has not received federal assistance. Mr. Graham and others worry that the government could find itself tilting key regulatory or purchasing decisions in favor of GM or Chrysler because of its interest in those companies.

What a mess.
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GM and Mixed Public-Private Ownership

Regular readers know that I prefer private ownership to public.  Markets are simply better at providing goods and services.  Unlike many writers, bloggers or otherwise, I do not believe that President Obama is a skulking socialist despite his mounting zealous interventions into markets.  Those who oppose his policy might extend their economic vocabulary of economic systems to better describe its weaknesses.

In a past blog post, I gave a partial defense for temporary nationalization of weak banks, arguing that this would be preferable to public-private ownership.  Briefly, I believe that the partial nationalization of GM is worse than the nationalization of a bank like Citibank because public-private ownership confuses institutional goals, and because the market structure of the auto industry is less competitive than the banking industry, increasing the probability of opportunistic behavior. 

Yesterday, the U.S. (60%) and Canadian (12%) governments, the United Auto Workers (17.5%) and previous bondholders (10%) became the owners of General Motors.  Because the ownership is mixed, the goals that the firm pursues will be unclear.  The government may try to produce environmentally friendly cars they believe are in the public interest.  The union may try to improve wages or other member benefits.  The former bondholders will want profits.  To produce environmentally friendly cars that do not maximize profits, the government may supplement profits with payments from taxpayers, or they may limit foreign competition.  Innumerable opportunities to circumvent market mechanisms exist.

The market structure of the auto industry compared to the banking industry increases the probability of opportunism by any of the owners.  There are simply few competitors making opportunism easier.  In a Wall Street Journal article titled, "Obama Motors Co." dated June 2, 2009, the authors give examples of conflicting goals and opportunistic behavior by the government to achieve its goals by weakening market mechanisms.

The Obama administration continues its campaign against bondholders. 

Every decision the feds have made since December suggests that nonpolitical management will be impossible...Treasury bludgeoned the bond holders in both Chrysler and GM to take pennies on the dollar, which will not make creditors eager to lend to the companies in the future.

Combating global warming and increasing energy security, two stated goals of the Obama administration, take a back seat in a small vehicle to the UAW, part of big labor, and major Obama campaign contributor.

There's also the labor agreement that the UAW approved last week, which goes some way toward reducing costs but probably not enough to make the new, smaller GM competitive. The new agreement simplifies some work rules and job descriptions but makes no reductions in hourly pay, pensions or health care for active workers. The agreement must also be renegotiated in two years by an Obama Administration running for re-election and weighing the need to keep Big Labor happy against the risks to taxpayer-shareholders. Who do you think wins that White House debate?

The Administration's concessions to the UAW also restrict the company's ability to import smaller, more fuel-efficient cars that it already makes overseas. UAW President Ron Gettelfinger boasted on PBS's "NewsHour" last week that "we, quite frankly, put pressure on the White House, the [auto] task force, the corporation" to bar small-car imports from overseas. GM is also selling its Opel operation in Europe as part of this restructuring, and the Washington Post reports that one of Treasury's sale conditions is that Opel's new owners must stay out of the U.S., and even out of China, where GM's business is strong.

  The Obama administration would exempt itself from antitrust rules it claims to value.

This is raw trade protectionism. It is also textbook cartel behavior and would be an antitrust violation if practiced by a business. But the benefits for GM are illusory because the import limits mean the company will have to spend even more to retool its domestic plants to make the little green cars that President Obama and Congress are demanding. No one knows if Americans will buy such cars, even if GM can make them competitively in the U.S.

Congress will also exert ownership control. 

The Administration promises to wield a light ownership hand, but it's only a matter of time before Congress starts to micromanage GM's business judgments. Every decision to close a plant will be second-guessed, much like a military base-closing. And what about buying parts from foreign suppliers? Will those also be banned when Mr. Gettelfinger demands it, even if the costs are lower? GM's managers and directors will have one eye on enhancing shareholder value, but the other on pleasing their political minders in Washington.

The larger corruption will be when government tries to vindicate its ownership by favoring GM over Ford and the other auto makers that aren't wards of the state. The TARP legislation contained one blatant example in the form of a $7,500 tax credit for consumers who buy GM's new electric car, the Chevy Volt. Expect more such favoritism, including huge new subsidies for green cars if consumers prove resistant to their charms.

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The Obama Administration and GM

The Obama administration has been the de facto owner of GM for some time, firing GM CEO, Richard Wagoner, hiring the new CEO, Fritz Henderson, broadly determining the new marketing plan and restructuring debt.  Through bankruptcy proceedings, the courts are making the federal government the de jure as well as de facto owners.  Peter Whoriskey, Kendra Marr and William Branigin of the Washington Post ("Obama: GM Restructuring Plan 'Full of Promise'," June 1, 2009) report President Obama comments on the bankruptcy filing.  

In a speech at the White House hours after GM filed for Chapter 11 bankruptcy protection in New York, Obama hailed GM's plan to emerge from its current woes as "credible" and "full of promise." But he also sought to reassure Americans skeptical about the plan's provisions to transfer a 60 percent ownership stake in the company to the U.S. government in return for an additional investment of about $30 billion during and after the bankruptcy process. The new infusion of cash will bring the total U.S. commitment to GM to about $50 billion.

"We are acting as reluctant shareholders, because that is the only way to help GM succeed," Obama said. "What we are not doing -- what I have no interest in doing -- is running GM."

Steve Rattner, head of Obama's auto task force also affirmed the government's desire for limited decision making saying that the government would be passive owners (Jim Puzzanghera. "U.S. role at GM to be passive, Obama vows,"  Los Angeles Times, June 2, 2009).  While past performance is no guarantee of future results, it often is illustrative.  I hope but doubt that government funding of GM is at an end as well as its intrusion into management.  The Obama administration should avoid mixed public-private ownership because there is ample evidence that this structure is problematic in the auto industry.  Ion Mihai Pacepa, the highest ranking Soviet bloc official granted political asylum in the U.S., and the author of the memoir "Red Horizons," was Romanian dictator Nicolae Ceausescu's "Car Czar."  He describes several unsuccessful government attempts to product cars, including his own which I quote below.

Ceausescu tasked me to mediate the purchase of a minimum, basic license for a small car from a major Western manufacturer, and then to steal everything else needed to produce the car.

Three Western companies competed for the honor. Ceausescu decided on Renault, because it was owned by the French government (all Soviet bloc rulers distrusted private companies). We ended up with a license for an antiquated and about-to-be-discontinued Renault-12 car, because it was the cheapest. "Good enough for the idiots," Ceausescu decided, showing what he thought of the Romanian people. He baptized the car Dacia, to commemorate Romania's 2,000-year history going back to Dacia Felix, as the ancient Romans called that part of the world. In that government-run economy, symbolism was the most important consideration, especially when it came to things in short supply (such as food).

"Too luxurious for the idiots," Ceausescu decreed when he saw the first Dacia car made in Romania. Immediately, the radio, right side mirror and backseat heating were dropped. Other "unnecessary luxuries" were soon eliminated by the bureaucrats and their workers' union that were running the factory. The car that finally hit the market was a stripped-down version of the old, stripped-down Renault 12. "Perfect for the idiots," Ceausescu approved. Indeed, the Romanian people, who had never before had any car, came to cherish the Dacia.

For the Western market, however, the Dacia was a nightmare. To the best of my knowledge, no Dacia car was ever sold in the U.S.

I hope that we can avoid the fiascos described by Pacepa; taxpayers are already on the hook for tens of billions.  Mitt Romney suggests a plan that would limit taxpayer losses ("Gordon Trowbridge. "Romney balks at government ownership of GM," The Detroit News, May 31, 2009).

The Obama administration and the United Auto Workers should immediately distribute their stock in a restructured GM to American taxpayers, former...presidential candidate Mitt Romney said Sunday.

I would be happy if the the government and the UAW sold their shares in monthly prescheduled blocks of ten percent beginning in January 2010. 
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More Bailouts?

The next beneficiary of tax dollars may be minority owned broadcasters (Silla Brush, "Democrats seek financial rescue of minority-owned broadcasters," The Hill, May 20, 2009)

High-ranking House [members] are urging the Treasury Department to prop up minority-owned broadcasters suffering from a lack of capital and lost advertising revenue amid the economic slump.

House Majority Whip James Clyburn (S.C.) is leading an effort to convince Treasury Secretary Timothy Geithner to take “decisive action” by extending credit to this sector of the broadcasting industry.

Clyburn and other senior members, including House Financial Services Committee Chairman Barney Frank (Mass.) and Ways and Means Committee Chairman Charles Rangel (N.Y.), argue that minority-owned broadcasters are sound businesses, but that the recession could undermine the government’s efforts to diversify the airwaves.

I have edited out of the quote references to party affiliation.

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AIG, Property Rights, Demagoguery, and Hate

My original interest in the AIG story was spurred by the expropriation of contractually specified bonuses. This is an abrogation of property rights and is bad for the AIG employees, employees in everywhere, and economy as a whole. The popular hate and ignorance as well as the blatant political demagoguery have expanded my interest.[1] In “Misguided Angst about AIG Bonuses,” I suggested that people expressing anger about the payment of contractual bonuses, be they residents of Main Street, activists or politicians, did so without establishing a link between the executives that made bad decisions that drove the company to financial despair and the bonuses. The link does not exist. The employees receiving the bonuses were not those that drove the company into a dysfunctional government receivership as Edward Liddy, the Treasury appointed CEO of AIG testified before Congress (Jenkins, Holman. “The Real AIG Disgrace,” Wall Street Journal, March 24, 2009).

Our elected representatives and their political appointees have known that the executives receiving the bonuses were not guilty of corporate malfeasance, yet they have treated them as if they had. Jenkins writes about the actions of several elected officials. I quote his article on three, New York Attorney General Andrew Cuomo, Treasury Secretary Geithner, and President Obama.

As far back as October, New York Attorney General Andrew Cuomo had summoned the Treasury-appointed Mr. Liddy to hammer out a deal on AIG's pay practices. Said Mr. Cuomo in a statement afterward: "These actions are not intended to jeopardize the hard-earned compensation of the vast majority of AIG's employees, including retention and severance arrangements, who are essential to rebuilding AIG and the economy of New York."

On March 3, Mr. Geithner himself was quizzed during a congressional hearing in detail about the AIGFP retention plan by Democratic Rep. Joe Crowley -- a week before Mr. Geithner now says he heard of the plan.

It may be that the full picture was kicked up to him only when a political decision was needed, but by then his one decent choice was to insist on the bonuses' legality. However politically inopportune the bonuses may be, the president only dirtied himself by authorizing a feel-good, bipartisan hate storm aimed at innocent AIG employees. And it's hard to believe Mr. Obama would have done so, or the subsequent spectacle would have unfolded as it did, without Mr. Geithner's seminal prevarications (and we say this fully acknowledging that he's had a rough ride in an inhumanly difficult job).

It is difficult to measure the size of the hate storm. After all, some people may not like the high levels of executive compensation but not support legislation mandating lower compensation or taxing high compensation at exorbitant rates. But if hate mail is a good measure of the intensity of feelings, our elected representatives have poured gasoline on a raging fire. Andrew Pergam, representing the Connecticut/News in “Threats to AIG: ‘We Will Get Your Children,’” (HT Drudge) gives many examples of hate mail received by AIG employees.

-- All you motherf***ers should be shot. Thanks for f***ing up our economy then taking our money.

-- Dear Sir: Ya'll should have the balls and come clean and give back the bonuses. I know you would never do this so the gov't ought to take you out back and shoot everyone of you crooked sonofb****es...I would be very careful when I went out side. This is just a warning. If I were ya'll I would be real afraid. Thanks, Bill.

-- I don't hope that bad things happen to the recipients of those bonuses. I really hope that bad things happen to the children and grandchildren of them! Whatever hurts them the most!!

And my favorite,

-- We will hunt you down. Every last penny. We will hunt your children and we will hunt your conscience. We will do whatever we can to get those people getting the bonuses. Give back the money or kill yourselves.

The emphasis added is mine, and I must ask if the author received inspiration from Senator Grassley of Iowa.

Jake DeSantis, an executive vice president of AIG’s financial products unit, defends his and many of his coworkers actions in “Dear A.I.G., I Quit!,” NYTimes, March 25, 2009.

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage…

Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.
DeSantis, like so many others, has been hurt b AIG employees who participated in the failed unit of AIG.

I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers.

The popular and political hate are having an impact on AIG employees.

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.’s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.’s promises and are not inclined to return the money as a favor to you.

The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to “name and shame,” and his counterpart in Connecticut, Richard Blumenthal, has made similar threats — even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.

DeSantis is not returning his bonus, nor is he keeping it.

I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn’t disagree.

That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn.

[1] I would like to thank a coworker who listened to me sound off at the political injustices foisted on AIG employees, and rightly pointed out that I needed to cool down, at least a little.

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AIG Bonuses

On the way to the gym, I heard a Foxnews account of Senators expressing indignation over AIG paying bonuses to executives.  While running on a treadmill at the gym, I watched a CNN account that was similar in tone and substance.  They got the story wrong, but many economists got it right.  Those that signed the Emergency Economic Stabilization Act (TARP), members of Congress and President Bush, should have been more careful in writing it.  They did not have the knowledge and incentives to run AIG and other recipients of bailout money, nor does the Department of the Treasury, nor does the Federal Reserve.  The members of the Congress who are expressing indignation should be ridiculed for hypocrisy, demagoguery, and foolery. 

Over two hundred economists signed an open letter to the Congress prior to the signing of the Emergency Economic Stabilization Act (TARP).  They are named at the end of the letter.  They wrote,

To the Speaker of the House of Representatives and the President pro tempore of the Senate:


As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses.  Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If  taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects.  If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity.  Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come. 

Their foresight in opposing the ill considered, rushed legislation should earn them respect and a larger policy voice in the future.

The best A good example of hypocrisy and demagoguery is Chris Dodd, as we learn from FoxBusiness via Russ Roberts at Cafe Hayek ("Awkward").  Dodd voted for the TARP legislation.

Senator Chris Dodd (D-Conn.) on Monday night floated the idea of taxing American International Group (AIG: 0.9468, 0.1667, 21.37%) bonus recipients so the government could recoup the $450 million the company is paying to employees in its financial products unit. Within hours, the idea spread to both houses of Congress, with lawmakers proposing an AIG bonus tax.

While the Senate constructed the $787 billion stimulus last month, Dodd unexpectedly added an executive-compensation restriction to the bill. That amendment provides an “exception for contractually obligated bonuses agreed on before Feb. 11, 2009,” which exempts the very AIG bonuses Dodd and others are seeking to tax. The amendment is in the final version and is law.

Also, Sen. Dodd was AIG’s largest single recipient of campaign donations during the 2008 election cycle with $103,100, according to opensecrets.org.

Senator Charles Grassely graciously provides the best example of foolery, calling on AIG executives receiving bonuses to resign or commit suicide.  Grassely also voted for the TARP legislation.  Like Dodd, he voted for the TARP legislation.  Because I quoted and linked to Russ Roberts yesterday, I will only provide the link today ("Grassely is Unhappy").

Did your representatives vote for the Emergency Economic Stabilization Act?  The Senate vote is here.  The House vote, here.

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James Hamilton On Improving Bailouts

James Hamilton of Econbrowser writes "Bailouts should be no fun." The trust of his argument is that bankruptcy proceedings are slow, freezing assets and lowering economic activity, exerting substantial spillovers or externalities on otherwise health pockets of the economy. A representative of taxpayers' could speed negotiations and lower externality costs by demanding concessions from owners, creditors, management, and workers in return for bailout funds. Taxpayers would benefit if the bailout funds were less than the avoided externality costs. Hamilton concludes,

If properly implemented, the taxpayers should leave the negotiating table pleased with the deal they achieved, and everybody else should leave battered, comforted only by the knowledge that, had they not made those concessions, things would have been even worse.

On the other hand, if everybody and their grandmother is lining up for a bailout, and pulling political strings...to make sure they get it, I read that as prima facie evidence that the taxpayers' interests are not being properly represented.

It appears that everybody and their grandmother is lining up. In a previous post, I named three banks, automotive firms, and a couple of pornographers. Cities, states, insurance companies, credit card companies and others can be added to the list. Hamilton's proposal might be a good way to shorten the line.

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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.

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Bush Blinked

Thursday night, Republican senators torpedoed a $14 billion bailout deal for GM and Chrysler.  The bill was killed by a few senators, mostly Republican, who were demanding union concessions before signing onto the plan.  Many of the senators were from states that have healthier non unionized automakers. 

In a policy reversal, the Bush administration announced that it may use TARP bailout money originally intended to shore up the ailing financial sector.  Bush blinked.  As an aside, perhaps the government should hire union negotiators to represent us when dealing with the Iranian or North Korean governments. 

According to Tom Krisher and Kimberly S. Johnson, the unions accused senators not supporting the bill of trying to kill the unions because unions gave $1.9 million to the Democrats and only $11,500 to Republicans in the last election cycle and to protect their states automakers who hire non unionized workers.  Mike O'Rourke, president of a UAW local at a GM factory in Spring Hill, Tennessee,

"What this is is the Southern conservative senators trying to destroy the United Auto Workers, trying to destroy unions.  It's a sad day in America when the senators turn their back on Main Street."

Mr. O'Rourke does not represents Main Street.  He represents the union, and is properly concerned with its and its workers welfare.  As a consumer, I want a high quality vehicle at a low price.  Currently, non unionized automakers are doing a better job at producing those cars.  I don't see how unionizing the other automakers helps the country or me.

The Krisher and Johnson article also noted that

Many Democrats support the Employee Free Choice Act, which would take away employers' rights to demand a secret ballot on whether workers will join a union. Instead, workers could form unions by getting a majority of employees to sign a card in support of it.

In an earlier post, A Love-Hate Relationship, I predicted, mostly in jest,  that Congress would force non unionized workers to unionize.  Little did I not know about the Employee Free Choice Act when I made the prediction.  For the life of me, I cannot see how taking away a secret ballot is democratic.  It sounds like a bill to authorize intimidation to me. 

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The Car Czar

The auto industry bailout legislation proposes a "car czar" who would oversee the implementation of the Detroit automakers' sweeping restructuring plan.

I wonder who will be the car czar? He or she will need more knowledge about the auto industry that thousands at GM, Ford and Chrysler who have spent their careers and considerable talent trying to make cars Americans want to buy at affordable prices.

In addition to extensive information about auto production, and consumer tastes, David M. Herszenhorn, of the New York Times, that the Democrats’ legislation calls for the czar and his or her team to have "appropriate expertise in such areas as economic stabilization, financial aid to commerce and industry, financial restructuring, energy efficiency and environmental protection."

Congress seems to believe that the automakers don't desire to capture the profit that a truly innovative product would bring, that other automakers have also purposely avoiding making or cannot make a green, fuel efficient car, that the knowledge to make such a vehicle is readily available to Detroit automakers, but not their rivals, if they just try a little harder.

With all that knowledge, the czar will also need to be a benevolent souls with a strong hand, able to sit down with interested parties, automakers, unions, creditors, suppliers, auto dealers etc., and hammer out agreements to implement the plan.

The same New York Times article also quoted Dana M. Perino, the White House Press Secretary who said "Mr. Bush would insist on aiding only those automakers that can survive long term."

Gee, the car czar must be near to all knowing, all powerful, and benevolent. I wonder who that could be?

A Few Side Notes:

1. Russ Roberts of Cafe Hayek has two great quotes, one by Hayek and the other by Adam Smith about knowledge and economic organization.

2. Russ Roberst also of EconTalk interviewed Jonathan Rauch, of the Brookings Institution and the Atlantic Monthly, about the Chevy Volt, GM's planned electric car. You can listen to the podcast.

3. Mark Phelan of the Freep.com writes 7 myths about Detroit automakers. Detroit's cars are not as bad as many believe.

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A Love-Hate Relationship

Reading the Drudge Report, my eye was caught by three related stories. "Man Says Wife Was Accidentally Shot During Sex..." This is the seedy story of an abusive, love-hate relationship. This was not the first violence suffered by the wife, Carolyn suffered at the hands of her husband, Tim. On another occasion, Tim spent 60 days in jail and attended anger management classes for beating his wife. According to the 911 call Tim said, "We were having sex, and it [the gun] went off." Doggone gun! It just went off when an otherwise loving couple were engaged in an act of congress.

The second article informed me of the consensual nature of the relationship, "The Big Three Drowning in Red, But Still Give Millions to Politicians..." Fifty million in lobbying, and another $15 in campaign contributions by those close to the industry--no surprise here. You didn't think that the our elected representatives would give away $34 billion for nothing did you?

Finally, I read, "Driving For Dollars: GM Chief Hits Road To DC" informing me that the relationship was love-hate. GM's CEO, who had the audacity to fly to DC in a corporate jet and ask for bailout money in November was being humiliated into driving in a hybrid car in December. Senator Richard Shelby, a Republican Senator from Alabama drew chuckles from the Banking Committee hearing room when he took time off from judiciously guarding taxpayer money to quip, "I wonder if they're going to drive back?" I'll bet ya that Senator Shelby wishes he had access to a fleet of Congressional jets. Congress keeps telling Detroit how to build cars that we want to buy; it's so good of them, the auto makers bleeding bottom lines were not sufficient warning. Cafe standards, law favoring unions, quota protection--love-hate. Doggone bankruptcy! It just goes off when otherwise well managed businesses and Congress were otherwise engaged in the people's business.

You can only push an analogy so far. An Act of Congress may save Detroit for now, but it is the taxpayer that is getting shot and in the wallet.

A Few Side Notes.

1. Don Boudreaux (The only stake here should be through the heart of any bailout proposal) and Russ Roberts (Do the car companies have a good plan?) from Cafe Hayek have two good posts pointing out that it appears easier to get money from politicians than investors.

2. Dr. B believes that Congress will protect taxpayer money by forcing foreign auto producers to unionize and thereby leveling the playing field for Detroit.

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