Carrots and Sticks: The Bailout and Unintended Consequences
"If you subsidize something, you get more of it." -Ronald Reagan
Everybody knows that incentives impact behavior. Parents provide allowances to get children to do their chores, businesses offer bonuses to motivate employees to reach their goals, and governments offer subsidies to encourage businesses to locate in their communities.
Positive incentives aimed at encouraging certain behaviors are called "carrots." Negative incentives aimed at deterring other behaviors are called "sticks." Everybody—from businesses to ballplayers—responds to incentives. Since they do, we need to be careful with their use and application, lest we produce grave unintended consequences.
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What then are the implications of the recently-passed Emergency Economic Recovery Act of 2008 a.k.a. the economic bailout? Will it produce unintended consequences? With the clamor to save our economy through massive government intervention in the marketplace, what message are we sending the businesses and executives who got us into this mess? What behaviors are we incentivizing in the marketplace?
In order to make that determination, we should examine the behaviors that got us here in the first place. A few of those behaviors are catalogued in a recent article in the Austin American-Statesman:
Bear Stearns engaged in abusive and illegal loan collection practices.
Bank of America, UBS, Merrill Lynch, Morgan Stanley and Wachovia deceived investors by selling them risky auction-rate securities advertised as being perfectly safe.
GMAC Bank and other student loan companies engaged in deceptive advertising.
IndyMac Bank routinely issued "liar loans" until it went broke.
Countrywide engaged in deceitful lending.
JPMorgan, Citigroup and CIBC engaged in securities fraud.
The supposed independent rating companies—Standard & Poor's, Moody's, and Fitch Ratings—gave bond insurers triple-A ratings to fatten their wallets when D-minus was what they deserved.
HSBC and Citigroup specialized in structured investment vehicles to conceal their risky mortgage holdings.
Freddie Mac failed to fully disclose its portfolio losses.
AIG hid huge losses on its credit default swaps.
Lehman Brothers failed to come clean about its real estate losses.
Lehman Brothers, Morgan Stanley, Citigroup, and Merrill Lynch competed with one another in developing abusive tax-evasion schemes.
It is a sorry tale, but it gets worse.
The CEO of Lehman Brothers, Richard Fuld, made $165 million between 2003 and 2007, even though his company had to file for bankruptcy on September 15 of this year. Merrill Lynch paid its CEO Stanley O'Neal $172 million from 2003 to 2007, and his successor, John Thain, got $86 million, notwithstanding that Merrill had to be sold last month for a share price that was about 70 percent below its January high. Bloomberg News reports, "Morgan Stanley's current and former chief executives, John Mack and Philip Purcell, were paid about $194 million over the past five years." The list of excesses goes on and on.
These men were entrusted with great power and responsibility, as well as with their investors' money. Nevertheless, they violated that trust through greed and deception. They enriched themselves at their investors' and the market's expense. Yet, when the market forces caused their companies to come crashing down, the government intervened to bail them out. What message does this send?
The government's position in the current economic crisis is exactly backwards. It will inspire even more greed among corporate executives by immunizing them from the natural consequences of their poor decisions. The message sent by the bailout is this: "It's okay to deceive your shareholders, enrich yourselves at your companies' expense, take on mountains of debt, and engage in reckless risk because Uncle Sugar will be there to bail you out when you fail. And, oh by the way, thanks for the campaign contributions!"
The government's bailout is a big fat juicy "carrot" for Wall Street miscreants. Congress' big wet kiss rewards Wall Street for its profligacy and immunizes it from the natural consequences of its executives' poor decisions. Rather than being punished by the market, AIG's executives are chilling at the spa!
Of course it's all being done for the taxpayer's benefit. Congress won't apply the stick to these bad boys because they are just "too big to fail." Innocent taxpayers might get hurt in the process.
Maybe, but come November, I have a feeling that taxpayers might just apply a stick of their own.
