Will 'Successful' Bailouts Lead to Future Ones?

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Published May 26, 2011

| FOXBusiness

Chrysler deserves to be applauded this week for returning $7.6 billion in bailout cash it received during the economic crisis six years ahead of schedule. Yet some free-market-loving Americans fear the repayments could give policy makers an excuse to splurge on bailouts during the next crisis.

They see the controversial rescues of Chrysler, General Motors (GM) and American International Group (AIG) as prime examples of the failure of free markets and the expansion of corporate entitlements.

“I think the temptation is real. I am worried about this,” said Douglas Holtz-Eakin, former director of the Congressional Budget Office and a one-time economic adviser to Sen. John McCain.

At the same time, the “successful” repayments of the bailout money can't help the moral hazard issues that government intervention into the private sector tends to create.

To be sure, the decision to save the auto industry saved tons of jobs -- by some estimates at least a million -- and likely prevented the economy from falling into an even deeper recession or even a depression. It also helped avoid putting further pressure on crumbling municipal budgets.

“In retrospect, it’s hard to say that wasn’t a good call,” said Dean Baker, co-director of the left-leaning Center for Economic Policy and Research. “I don’t think as a general rule we want to have bailouts all over the place of non-financial companies. It should be looked at in exceptional times.”

And the auto bailouts did largely go as they were drawn up. Chrysler paid back its $7.6 billion in loans to the U.S. and Canada ahead of schedule and even paid the Treasury Department $1.5 billion in interest and fees. Earlier this month Chrysler reported a 36% jump in revenue and a profit of $116 million, its first since exiting bankruptcy nearly two years ago.

Likewise, GM returned to the public markets this year, becoming the largest U.S. initial public offering ever. The auto maker tripled its first-quarter profits and is neck-and-neck with Toyota (TM) for No. 1 in global auto sales.

What Free Market?

Despite the companies’ successes and the U.S. recouping much of its investment, the bailouts still stand in opposition to the free-market ideals of this capitalist system.

“Some of it doesn’t sit well with me,” said Ernie Patrikis, a partner at White & Case and a former high-level official at AIG and the Federal Reserve Bank of New York. “What other industry do we think will be important in the future where there are a lot of jobs and votes that will cause the government to act? We should try as much as possible to eliminate the potential for that happening.”

The rescues of private companies also represent an expansion of corporate entitlements, much like the social entitlement programs like Medicare that provide important social benefits to many Americans but are weighing down the country’s bloated balance sheet.

“Businessmen [complain] about government and taxes, but will take the subsidies. It’s a fact of life,” said Holtz-Eakin.

To that point, Patrikis said he doesn’t believe there’s been a truly free market since 1900.

“There’s a hell of a lot of law and a hell of a lot of regulation. That’s not free market,” he said.

Charles Geisst, a finance professor at Manhattan College and author of Wall Street: A History, said he’s not really worried Chrysler’s ability to repay its loans will tempt the government to do more bailouts.

“I think this happens so rarely that it doesn’t really establish a precedent,” said Geisst.

He also noted there is a history for crises to cost less than projected. The Savings & Loan Crisis of the late '80s and early '90s was originally estimated to cost $300 billion but ended up costing about half of that.

Geisst and others who support the bailouts recognize the danger that materializes when companies begin to feel entitled to a taxpayer-financed rescue. This concept is often referred to as moral hazard and covers companies that are deemed (or believe they are) “too big to fail.”

Some believe policy makers let banks and other companies off the hook by not taking enacting harsher penalties that would serve as deterrents for taking risky behavior in the future.

“It was not a 'yes' or 'no' proposition,” said Baker. “We could have dictated terms.”

Baker suggested a number of steps the government could have taken given its leverage, including wiping out shareholders, forcing bondholders to take a haircut, removing well-paid management teams in place and forcing companies to commit to fundamentally changing their risky behavior.

“Moral hazard is real,” said Holtz-Eakin. “If you have large manufacturers who perceive themselves to be important to America, they may be more risky knowing the government has a backstop. You’re not literally thinking, ‘I’ll just let the government pick up the tab,’ but you’re less prudent.”

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