5 Bailout Absurdities

Some strange things are happening to American capitalism.

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Last fall, it probably made sense to flood the financial system with money, to prevent a panic that could easily have compounded a nasty recession. But that was then. As the bailouts have proliferated, so have the unintended consequences, and the financial system is starting to look like a fun-house version of American capitalism.

As the Obama administration enters a new phase in the financial bailout, here are some of the perverse developments that ought to be reexamined:

Bailing out profitable firms. In normal times, nobody would think of giving taxpayer funds to companies able to survive on their own. Yet that’s exactly what we’re doing. Goldman Sachs, Exhibit A, is sitting on $10 billion in government loans even though it earned $1.8 billion in the first quarter. Wells Fargo, which has gotten $25 billion, expects its first-quarter profits to come in at about $3 billion. Several other major bailout recipients, including JP Morgan Chase, will probably be profitable for much or all of 2009.

[See how bailouts can butcher capitalism.]

What gives? The original idea was to boost capital throughout the banking system, to make more money available for loans. The feds also hoped that funding all the banks would eliminate any stigma associated with a bank accepting federal money, forestalling the risk of a run on banks deemed sick. It was also quite possible last fall that all the bailout recipients would actually need the money – especially if the economy completely seized up, as some economists feared.

We seem to have dodged that bullet. Credit has slowly started to flow again, and it’s starting to look like lending is down not because the money’s scarce, but because consumers and businesess don’t want to spend money or ask for loans. Meanwhile, banks that have received federal money are chafing under government scrutiny of pay, perks, and business practices. And taxpayers are simply sick of bailouts. Federal funding for companies that can fund themselves is an idea whose time has come, and gone.

[See why more companies are likely to fail this year.]

Loans that the borrowers aren’t allowed to repay. The government wants all of its bailout money back – just not yet. The feds are worried that banks seeking a PR boost will pay back their bailout funds before they’re ready – then suffer more losses down the road and end up back at the government teat. The plan now is to first complete the bank “stress tests” to determine how healthy the biggest bailout recipients are, and only then consider payback plans. Even then, the government may refuse to allow early paybacks, because the banks that don’t step forward will look weak by dissociation.

Goldman Sachs is challenging this federal paternalism and pushing hard to end its arrangement with the federal government. Wells Fargo has complained about the whole bailout regime and may even be burnishing its first-quarter numbers as a pretext to pay back its loan and get the government out of its business. Let them. It’s time to recoup taxpayer money from those able to pay it back, and if that exposes competitors as weak – well, that’s how capitalism works.

[See why Goldman Sachs should repay its TARP money.]

Everybody wins. So far, the financial bailout has played out like a soccer game for six-year-olds: Everybody wins and nobody’s feelings get hurt. Enough of that. It’s time for leaders to emerge, and if weaker competitors falter or fail as a result, the good news is that the nation’s financial safety net is a lot stronger than it was last fall. Besides, at some point, the risks of propping up weak companies exceed the risks of letting them fail.

The Obama administration seemed to acknowledge that in its recent response to GM and Chrysler, giving the foundering auto companies a tough set of conditions to meet in order to get any more federal money. If they come up short, they’re welcome to try their luck with a bankruptcy judge. Banks are a bit different, since they supply the capital that the rest of the economy needs in order to grow. But still, they deserve tougher love than they’ve been getting.

[See why the auto bailout is a good model for other bailout-seekers.]

Congress, Inc. Those Merrill Lynch and AIG bonuses may have been disconcerting, but Congress’s reaction was even more alarming. Provisions to enact tax laws aimed at a single corporation – AIG – reveal the dangers of angry legislating. Others proposals to limit pay, select managers, and set interest rates at banks receiving bailout money threaten to establish a two-tier banking system in which privately run banks respond to market forces, while government-controlled banks respond to political forces. That’s hopeless. The market produces excesses, but so does Congress. And the market has better self-correcting mechanisms.

[See 5 lessons from the AIG and Merrill bonuses.]

The $1 CEO. Ed Liddy, an outsider who took over as the chief executive of AIG last fall, has one of the hardest jobs in America. He has to dismantle a dying giant of a company, preserving the vital organs while excising an entanglement of financial malignancies that could still threaten the global economy. For this, he’s getting paid $1, while also being treated to perks like a Congressional whipping every now and then. The CEOs of Fannie Mae and Citigroup agreed to similar salaries, as if sacrificing a paycheck atones for the sins of their predecessors.

[See 7 surprises buried beneath the AIG bonuses.]

Are Americans suddenly averse to fair pay for hard work? Let’s hope not. Obviously there’s a lot of justified sensitivity about overpaid bankers who earn millions with no accountability for disastrous decisions. But paying a pittance to people who are actually solving big problems and restoring value is no solution, even if they’re willing to do it. We need to outgrow phony symbolism and pay people what they’re worth. Otherwise, we devalue the whole notion of honest work, and risk making bailouts a way of life.