Joshua Fershee: Bailout has to have strings

GM as deserving as Bear Stearns, however taxpayers need protection

September 7, 2008 • From Lansing State Journal

Josh Fershee


Recent government-arranged bailouts for Bear Stearns and the lenders Freddie Mac and Fannie Mae have raised questions as to who's next? The debate has focused on Detroit, primarily on General Motors, as the next likely candidate for a government orchestrated bailout.

From the Wall Street Journal to the Los Angeles Times, calls are mounting to "ignore Detroit." However, beyond mounting costs, there is little explanation as to why further bailouts are any more unwise than the earlier bailouts.

The stated rationale in support of government intervention is that some entities are simply "too big to fail." That is, the government has determined that continuation of the company is so important that the government must act to prevent the company's failure. If Bear Stearns and Fannie Mae are too big to fail, then so are the Detroit Three. Any argument that Bear Stearns is more significant than GM is largely an argument that markets are more important than people.

And that is plain wrong.

This does not, however, mean bailouts are a good idea. To the contrary, without any measures to mitigate the harm and cost of government intervention, all bailouts place government (meaning taxpayers) in the role of fee-free insurer for the largest companies.

If the U.S. government is going to operate as an insurer, bailouts should be run like other government insurance programs.

Take, as an example, the National Flood Insurance Program. The U.S. government makes flood insurance available in communities willing to adopt and enforce a floodplain management ordinance. The stated purpose of this program is "to provide an insurance alternative to disaster assistance to reduce the escalating costs of repairing damage to buildings and their contents caused by floods."

In this instance, the government recognizes the reality that it will step in following a natural disaster, and thus has taken steps to mitigate the impact (i.e., costs) of such a disaster.

If the federal government is going to be in the business of bailing out extremely large companies, then similar steps should be taken to mitigate the costs of such bailouts. As a prerequisite to approving a major merger, the Department of Justice and the Federal Trade Commission could require the resulting entity to make divestitures or require the company to pay for government-supported insolvency insurance. For existing companies that are already "too big," the SEC could similarly require that a "dangerously large" company pay for insolvency insurance.

After all, the government is already providing the insurance in the form of bailouts, but currently it is being provided free of charge.

It should sound a little absurd to propose that government would get into the business of deciding when a company is too big, but it is not any more absurd than providing free money to large, poorly run and over-leveraged companies. If Bear Stearns "deserved" a bailout, so does GM. But bailing out Bear Stearns, without creating any protections for taxpayer investments, was a mistake - a mistake that shouldn't be repeated for any company.