The Next Round of Bailouts: The States

So with all these bailouts, one of the effects they are having is greatly increasing the moral hazard throughout society. One of the reasons why we are in the mess we are currently in is that a huge moral hazard was created via the implicit guarantee of Fannie Mae and Freddie Mac. Investors correctly felt that the institutions would be bailed out if they got in trouble and this allowed the two firms to borrow money at a below market rate and pump an excessive amount of capital into housing. So apparently not learning from our lessen, we’re now doing exactly that again with banks, auto makers, your uncle who’s delinquent on his credit card and so on.

So the next one on the list is bailing out state governments. Senator Schumer has stated that his state of New York will likely be getting $5 billion in increased transfer payments via the Obama administration's proposed stimulus package. It has also been suggested that California is to be bailed out. One of the beauties of State governments is that unlike the Federal Government, they cannot borrow endlessly. This is mixed with the fact that if they raise taxes to too high of a level residents and businesses will move out. These two forces combined place a check on State budgets and this forces them to be fiscally responsible and relatively efficient. These two mentioned states, along with many others went on spending sprees in the most recent good years without regard for long-term planning. California’s budget grew almost 30 percent in the past 3 years. But now that the Federal government will step in and bail them out, the moral hazard of over spending has increased greatly for years to come. The California legislature is being resistant to spending cuts currently. Perhaps it’s because they know if they wait long enough, they will be bailed out? Now every state legislature knows it does not need to keep spending in line or create rainy day funds for use in recessions, because every time we get into one, they are going to be bailed out.

This creates the obvious problem of promoting irresponsible behavior on the part of the States, which ends up being paid for by the Federal taxpayer. Beyond that however, is the continued erosion of the notion of the States being sovereign bodies. Rather than being independent levels of government, if the budget processes are now created with the assumption of Federal help, the States become more similar to the French Departments, merely administrative districts rather than separate governments. Power therefore only becomes more centralized and less in touch with constituents. Furthermore, how come New York and California are the ones in which the bailouts are being designed? Why not Rhode Island, Virginia or Arizona, which have huge budget problems themselves? Could it possibly be that both these states are heavily Democrat (and therefore the same party as the current controlling government) with influential Congressmen representing both of them, including the Speaker of the House, the Chairman of the Ways and Means Committee, and a woman soon to be Secretary of State? Bailouts just become another mechanism of corruption and party hackery. Just as soon to be former Senator Stevens was allowed to get away with his abhorrent pork projects because his party controlled Congress, so will those who now have favor with the current government.

-EJB


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It certainly seems like, in this new culture of bailouts, there ought to be an increased risk of the moral hazard that EJB mentions. After all, it stands to reason that if the Federal Government is willing to bailout banks for bad business practices - and now, apparently, some States for their failure to adequately plan for their future - other sectors of business (and indeed, other States) would feel comfortable knowing that their fiscal shortcomings will be federally insured. I'm not sure it's just that simple though. Look especially at the recent automobile bailout. Officially, I guess it is a bailout but the bill never got through Congress; Bush had to semi-legally divert funds to GM from the original "stimulus package." I think it's safe to say that a large contingent of the population (and of Congress) is tired of taxpayer bailouts. This shifting of public will may not allow for further bailouts. Furthermore, all it takes to soften the blow of the moral hazard is one major bailout proposal rejection. We may have seen that with the auto bailout. If the Federal Government refuses to bailout a company or State that is asking for money, other entities won't be so quick to assume that they'll be guaranteed any sort of insurance.

Now to the California and New York stuff. Again, I think it's sort of facile to point out that NY and CA are liberal states and thus, wink wink nudge nudge, they're getting bailed out. I'm not saying there isn't some truth to that, but EJB points out later in the post that Rhode Island isn't being bailed out. Is there a more liberal State than Rhode Island? I've lived there. There is not.

Also, I bet we could discover all sorts of plausible rationales for the bailing out of New York and California. My first thought was to note that these are two of the largest States, by population, in the country. In fact, they are first and third in that category. Thus a State business bailout or a capital injection that props up Medicaid in New York helps more people than a similar plan in Arizona. Perhaps Obama, curtailed by a sinking economy, is implementing a fiscal triage.

But maybe you don't buy this strict utilitarian explanation. Fine. I think another relevant factor in the bailing out of California is the fact that the State is literally out of money. As much as I'd like to back EJB's moral/philosophical argument about moral hazards and learning important lessons, it's probably vitally important to first make sure that each State has enough capital to continue its operations. Otherwise we're simply winning the battle to lose the war. Or perhaps we'd be throwing the baby out with the bathwater. All I know is, there must be some folksy idiom that applies here.

As for NY, another possible explanation for bailing it out is that this could be a very good move for the national economy. NY ranks fifth amongst the States in GDP per capita. Thus it seems logical to conclude that more business is done in NY. Complete the syllogism and it points to the fact that bailing out NY is more economically beneficial for the Federal Government than bailing out Alabama.

So anyway, I'm not sure why they're doing this. Perhaps EJB is correct and this is merely a political pork move. I think there's probably some truth to that. But I propose that there are other, more legitimate, reasons for the NY and CA bailouts.

~JSK

The Auto Bailout Is Here and on Shaky Legal Grounds

So details are yet to come out, but the Treasury announced this morning that GM and Crysler will get a $17.4 billion loan through at least March 31st to be taken out of the TARP program (the $700 billion bank bailout). This is likely only the first installment.

But you've got to love this administration. The bailout failed to get Congressional approval, so they just go around it and do it themselves with the proverbial FU. Where the Treasury gets the legal authoirty to do this when the bill passed uses language that clearly states it is to be used for financial institutions only, is a mystery to me. The bill defines "Financial Institution" as:

FINANCIAL INSTITUTION- The term ‘financial institution’ means any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government.

But then again since when does this administration or the Federal government in general care about following the law? I will be interested in seeing if and how many Democrat Congressmen come out against this action, considering it is violating the bill but at the same time the end result is something they want and tried to get through Congress. We will have an oportunity to see if the years of complaints by Democrats about the Bush administartion breaking laws was true outrage in principal or whether it was just political opportunism. In this case they are fine with breaking laws as well as long as its for their purposes. I'll be watching.

UPDATE: Obama's reaction:

Today's actions are a necessary step to help avoid a collapse in our auto industry that would have devastating consequences for our economy and our workers. With the short-term assistance provided by this package, the auto companies must bring all their stakeholders together — including labor, dealers, creditors and suppliers — to make the hard choices necessary to achieve long-term viability.

Maybe he would have preffered it go through Congress, but it looks like he's ok with the executive branch stretching and bending both the spirit and letter of the law as well. So much for "change." It will just be a different set of issues in his Presidency in which the end justifies the means.


-EJB

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Sorry for my absence lately, everyone. EJB has done well to hold down the fort while I finish up my finals. It's all over now so, let's get right back into it.

I'm pretty sure that absolutely nobody is shocked by this move. The Bush Administration has done nothing if not circumvent federal law every step of the way. Let's talk about the language of the TARP that EJB highlights.

Clearly, the plain meaning of those words leads to the conclusion that an auto company is NOT a financial institution. I fully expect a lawsuit to climb the court-ladder and be available for certiorari soon (though, the tricky aspect will be who has standing to actually bring the suit). But the Bush Administration has a plan - of this we can be certain. They would not have pushed forward with this move if their legal counsel hadn't advised them of a litigation strategy, should their move be challenged.

One clause, in particular, worries me. That a "financial institution" can be labeled as a "security broker or dealer" or an "insurance company" might be the text that the Bush administration relies on. Do the automakers insure their sales? Do they buy and trade in other company's securities? If so, it is entirely possible that a court could label them a "financial institution." EBAY was so labeled in a case under Delaware Corporate law - despite the obvious fact that EBAY is not a financial institution. But because EBAY dealt in corporate securities - and lots of them - the court found it fit to consider them a securities dealer. This, I think, would have to be Bush's defense plan, should his illegal move be challenged.

And can I just mention one more time, what the hell is going on with this Republican administration!? Congress, despite being strongly Democrat, shoots down a bill that would help auto companies (traditionally a strong Dem interest) and then a Republican president circumvents Congress and exerts fictional Article II powers to redistribute capital!? WHAT!? What country are we in? What year is it? This whole thing blows my mind.

~JSK

Summing Up the Total So Far

So pretty much everyone is aware of the $700 billion “bank bailout” and the pending “auto bailout,” but what most people don’t realize, is that these are only a fraction of the total government expenditures and guarantees that have gone on so far over the past year. Government agencies and the Federal Reserve, which get less media attention and have no legislative hurtles have gone about instituting many other programs on their own.

So I was reading a WSJ article this week that has outlined that the Federal Reserve’s balance sheet has exploded in recent months, ballooning from about $800 billion to about $2.2 trillion since September. For the most part, the Fed has essentially printed $1.4 trillion dollars to purchase or borrow other assets. If this is kept in the system for too long once a recovery begins, we will be seeing inflation like we haven’t seen for years. The Fed says that it will tighten its policy when needed, but given their recent track record, I wouldn’t put much faith in that. And the market seems to agree with me as gold has been inching up recently.

But this whole thing got me thinking and I went about grabbing other info I have accumulated recently and came up with a list of all the various programs created over the past year. I’m probably missing a few small ones, but here is what I came up with.

(If amount allocated is yet to be used in it's entirety, the amount used thus far is in italics.)

Federal Reserve - $4.75 Trillion

Commercial Paper Funding Facility - $1.8 trillion ($312 billion)
Buys short term notes from private firms

Term Action Facility - $900 Billion ($415 billion)
Auctions off loans to banks

Term Securities Lending Facility - $250 billion ($190 billion)
Allows financial firms to borrow treasury bonds in exchange for low quality debt

Money market Investor Funding Facility - $540 billion ($0)
Buys assets from financial companies that support money market funds

Credit Extension to AIG - $123 billion ($87 billion)

Citigroup Bailout - $291 Billion
Guarantee of toxic assets

Discount Window - $92 billion
Banks directly borrowing cash from the Fed

Discount Window II - $50 billion
Extends direct bank lending function to securities firms

Commercial Paper Program II - $62 billion
Loans money to banks to buy commercial paper from mutual funds

Bear Stearns Bailout - $29 billion ($27 billion)
Guaranteed assets in brokered JP Morgan buyout

Overnight Bank Loans - $10 billion

Other Assets - $606 billion
Includes treasury bonds purchased with printed cash in order to help finance the government

FDIC - $1.55 Trillion

Temporary Liquidity Guarantee Program, Secured Debt Guarantee Program, Transaction Account Guarantee Program, increase of deposit insurance limit and other interbank lending guarantees - $1.4 Trillion
Various insurance programs backing debt between different parties

GE Capital Bailout - $139 billion
Debt Guarantee to General Electric's lending arm

Citigroup Bailout - $10 billion
Guarantees Citi’s toxic assets

Treasury Department - $947 Billion

Troubled Asset Relief Program - $700 Billion ($336 billion)
Originally for purchasing distressed assess; now for buying equity positions in companies

Stimulus Package - $168 billion
“Rebate Checks” of earlier this year as well as some other minor tax credits

Bank Tax Credits - $29 billion
To compensate for the government wiping out Fannie and Freddie securities held by banks

Treasury Exchange Stabilization Fund - $50 billion
Designed to manipulate currency markets - now used to insure money market funds

Federal Housing Administration- $300 Billion

Loan guarantees for refinanced mortgages for struggling and delinquent home owners

Nationalization of Freddie Mac and Fannie Mae - $5.2 Trillion

Capital Injection - $200 billion ($25 billion)
Government buys preferred shares and opens up line of credit

Mortgage Debt Guarantee - $5 Trillion
Government acquires the guarantee on all mortgage securities sold by the two GSE’s

Total Earmarked: $12.45 Trillion - Used So Far: $8.74 Trillion
Spent: $4.09 trillion
Loans: $1.49 trillion
Guarantees: $6.78 trillion

Likely to be passes soon:
Auto Bailout: $75 to $125 billion
Stimulus Package: $500 to $850 billion

(Sources: FDIC, US Treasury, FHA, Federal Reserve, Washington Post)

Keep in mind too that these are only the new or expanded programs. This list does not include preexisting “normal” expenditures like increased unemployment compensation or the FDIC deposit insurance. Even without these, the totals are mind boggling. With the likely auto bailout and upcoming stimulus package, various government bodies will have spent, loaned out or insured somewhere around $13 trillion in less than a year! To put this into perspective, the entire output of the US economy in a year is about $14.4 trillion. The amount of $13 trillion is larger than the annual economic output of China, India, Brazil and Indonesia combined, the four largest countries not including the US, which include over 2.9 billion people. This amounts to about 30 percent of all financial wealth of all US households combined. Or it translates into about $43,000 per US resident or about $108,000 per household! So this is your piece of the pie so far.

Now all of this isn’t spent money. The majority is either loans or insurance, so all the money will not be lost. Likely, most of the loans will be paid back and not all the insured assets will go bad (though a lot of them will). Furthermore, much of the spent money went to buying assets that will likely have at least some value to sell back later on.

I guess my point however is to show exactly how large and unprecedented this is, and that is goes far beyond the “bail out” bills. At the macro level, the government has essentially taken control over the entire financial system. In broad areas, capital is no longer largely allocated to areas that investors believe are most profitable and therefore most productive, but rather to what areas government has deemed it to go to. And much of this has been done by agencies and the Fed using extremely loose legal interpretations of their powers. The amount of raw power and authority the Fed, FDIC, and Treasury have been allowed to wield without Congressional approval is unbelievable. Distortions are done directly by the partial nationalization of the financial industry (soon to be done with the auto as well), or it’s done by placing guarantees on various assets, incentivizing more capital to flow into these over other alternatives that government bureaucrats deem less worthy. Event the stock market of recent months reacts little to earnings reports and instead has violent swings based one expectations of various government actions.

We are now in a political economy. The gigantic “stimulus package” soon to be passed is going to be the largest pork barrel project in history as every mayor, governor, and special interest down to a city councilman’s cousin who owns a paving company is lining up to the trough for a piece of the handout. This is the closest thing to a command and control economy that this country has faced since WWII. And all this done under the watch of a President whose critics have attacked him for being a “free market ideologue.” If this is what a champion of free market capitalism brings us, I don’t even want to know what the next administration and Congress is going to do. Maybe buying gold is looking good right now.

-EJB

Bailouts: Italian Style

So in the US, we bail out the banks, the auto companies, the insurance industry... So what does the Italian government do? They bail out the Parmesan cheese industry!

Producers sought government help in the face of prices that have fallen some 25 percent over the past five years, said Giorgio Apostoli, who represents dairy farmers for the Coldiretti agriculture lobby. The producers faced pressure from distributors who offer sharp discounts on the grateable cheeses to lure shoppers into supermarkets

So thanks to the industry's lobbying power, at the expense of taxpayers the government will buy up 3 percent of annual production in an attempt to drive the price up. The official reasoning... to buy food in order to give to the poor. But of all the things you can do for a food program, the government decides to go with Parmesan cheese?

In reality, just as the auto companies come crying to the US government looking for money because they make inferior products that can't stand up to competition, so do the cheese makers. So instead of letting consumers purchase the cheese that they want to buy at the given market price, thanks to their elected officials, Italians will now have to use their tax dollars to make their cheese more expensive. Looks like lobbying power wins out again. Instead of spending the resources to innovate, cut costs or find some other way to compete in the marketplace, they instead decide it is worth while spending resources lobbying so the government can use other people's money to keep them in business, harming society as a whole. As Jeff Flake, one of the few Congressmen I actually like famously said, "I would argue this is one cannoli the taxpayer doesn’t want to take a bite of."

-EJB

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When I first read EJB's post, my immediate reaction was to begin my response with some tasteless ethnic jokes about Italians - seeing as both EJB and I are (at least half) Italian, and I figured I could get away with it. On second thought, this might not be the place for such offensiveness. Rest assured, my jokes would NOT have been about smelling bad and beating your wife...

Anyway, I had two non-offensive thoughts after reading the article. First, the Italian government's stated purpose for the "bailout" (they're actually just agreeing to buy one hundred thousand wheels of Parmesan) is that they will donate the cheese-wheels to the needy. So it's win-win; Parmesan cheese-makers get to stay in business and the poor get fed. But wait, they're giving Parmesan cheese to poor people? What are they supposed to do with it, sprinkle it on top of their non-existent soups, salads and all-you-can-eat breadsticks? Who gives someone a wheel of Parmesan cheese when they're hungry? I kind of find this cruel: "Oh you're out of money and starving? Here, have this 66 pound wheel of crumbly, foul-smelling curdled milk." Come on Italy, the last thing your hungry need is Parmesan cheese. Man up and confess that you're only doing this to bailout an important industry that probably donates money to Parliament members.

My second thought was the role the EU plays in the great cheese bailout. The article EJB links to mentions an EU program that is intended to help feed the hungry. It also implies that some of the bailout money will come from the EU itself. From what little I know about EU law (and believe me, I have a very limited knowledge of the black-letter law itself), EU monetary disbursements of this nature only go towards (or primarily benefit - again, I'm not completely sure of the legal language) foods or beverages which have been labeled with "Protected Designation of Origin" status. Sure enough, Parmesan cheese is just such an item. Thus, as European economies continue to stumble alongside ours, we can look forward to other wonderful EU bailouts of Asiago cheese, Champagne and - my personal favorite - "Melton Mowbray pork pies."
I would not eat that.
~JSK

This Would Be Even Funnier If It Weren't So True

-EJB


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"America needs the money hole!"
"I love the money fires."

Brilliant, yet tragic...though the idea of people arguing over whether the free market can discover the best way to destroy money warms my heart.

~JSK

A Caricature of Bush's "Conservatism"

President Bush, in what could be the final important act of his presidency, is lobbying hard for a $25 billion dollar "bailout" (read:investment) of the Big Three American automobile makers - GM, Ford and Chrysler. Taxpayer money would essentially be used to buy an ownership stake in the companies, with the attempt of keeping them afloat and potentially reimbursing tax-payers once their stocks rise in the distant future. Essentially, this would be a partial nationalization of the automotive industry; and it comes under a GOP President - oh, the irony.

I would like to think of this act, should it pass, as a caricature of Bush conservatism. In other words, the exact opposite of what conservatism meant only 20 years ago. There is little doubt that, had you told Goldwater or Reagan that a conservative President would expend political capital to nationalize a major American industry, they would not have believed you. Small government and free market ideology were at the heart of conservatism.

But oh how things have changed. Bush, who recently publicly defended the free market system, has either changed his mind on that sentiment, or just does not understand the definitions of the terms "free" and "market." Or maybe even "the" and "system." (It's not unprecedented for a President to be unsure of even the simplest definitions, remember that Bill Clinton was perplexed by the meaning of "is.") Now, Bush advocates for bailing out companies that have failed on the market. Consumers agree (as indicated through horribly failing stock prices), GM, Ford and Chrysler cars are not worth their price. Facing competition from Honda and Toyota, Japanese imports that are - on the whole - cheaper, more efficient, get better gas mileage and last longer, American car companies have struggled in the last decade. Some chalk this up to the incredibly poor business decision made by many of these companies to pursue an increased development and production of gas-guzzling SUV's. That is certainly part of the picture. What seems to be going unsaid, however, is that the products these companies make are just horrible. Have you driven a Chrysler lately? It is not worth its weight in salt. My family owned a Chrysler mini-van for a few years. I can remember the transmission falling out of that van on at least three separate occasions. The front axle was always misaligned. And it handled incredibly poorly in snow and ice. These factors -and doubtless many more - played substantial roles in pushing customers towards buying foreign cars. Now, suddenly, we're talking about bailing out businesses that create and market inferior products. They have failed on their own merits - it is time to let them find their own way to succeed. I would suggest (should the CEO's of these companies be reading this page, which I'm sure they are) that they retool their operation entirely. Trucks and SUV's are floundering thanks to a surge in consumer gas conservationism. Hybrids and low gas-mileage cars are clearly the future. Work on that.

Now, I am not blind to the other side of the story. Two competent reasons are put forward for saving these industries. First, they employ a great deal of workers. Allowing them to go under would drastically increase unemployment and the poverty rate - especially in Detroit, a city which could itself use a bailout. Second, if these companies were to collapse, we would miss their manufacturing plants if we ever become involved in an old-fashioned international state-to-state war. The likelihood that this will happen is remote; it seems like the "war on terror" is the foreseeable altercation our country has decided to engage in. But should a war with Russia or China or some other mechanized state erupt, the loss of car manufacturing plants would cripple our ability to domestically manufacture military trucks, tanks and other necessary equipment.

Thus, I am not advocating that we should not bailout the auto industry. There are valid arguments on both sides. What I am merely pointing out is that our current President, a purported conservative, is fighting the hardest for this attempt at nationalizing the automotive industry. I find that ironic and indicative of the current state of the GOP.

~JSK

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First, I'm not so sure the Bush administration is the one really pushing for the nationalization of the auto industry. They have been luke warm thus far. This one has been more driven out of Congressional Democrats. But obviously it was the administration that initiated the push for the financial bailout.

But I agree with this point. One of the most frustrating things from the viewpoint of a Conservative is that Bush is seen as the example of what conservatism is. Goldwater and even Reagan are rolling over in their graves right now. We have had a huge government Republican claim the mantle of conservatism. Under his rule, government power, and in particular executive power has only increased in any way you measure it and government spending has exploded. This is no conservative. He is more synonymous with the old socially conservative Southern Democrats - he's a Dixiecrat. With the exception of some of the social issues, his presidency has more in common with LBJ's then any other modern president.

Though this was written before the financial mess in September and October, Charles Wheelan has a similar discussion on Bush in that he doesn't know what he is. He calls him a "neo-neoconservative", all the liberal spending without the perks. Read here.

-EJB