Bailouts

Why is it that the government keeps bailing out failing corporations? Whether it is Chrysler, the Savings and Loans, Airlines, or Bear Sterns? And now Congress is suggesting bailing out people who took out mortgages that they could not afford?

Since deregulation the Airline Industry as a whole has not been profitable, having lost a total of $13 billion over approximately 30 years. Yet time and time again, the government has bailed out the airlines. If the airlines had been left alone, many would have failed and the market would have corrected itself, but since the government is artificially propping up failing business, they don't change, knowing Uncle Sam will be there to get them out of a jam. This has kept airlines from reworking the basic business model so that they can make a profit.

Looking at the so called mortgage crisis, talk once again turns to the government bailing out institutions and individuals that made bad decisions.

Mortgage Lenders (such as Fannie Mae) made bad assumptions about the economy and the housing market and the rate of default. Why did they make such bad assumptions? For one thing, they figured that they would be able to reduce some of the risk by packaging loans into bundles (bonds) and selling the loans. The lenders then told the investors in these bonds, that they has certain risk associated with then and a certain interest rate, but didn't tell the investors what the model was that they used to come to these conclusions.

The investors (such as Bear Stearns) didn't question the lenders, they assumed that since the lenders had been right in the past, they would still be right, and bought these loans without proper investigation, or any contractual obligations to insure that the lenders packaged the loans correctly and modeled for situations such as the housing bubble bursting. Everyone, knew that there was a housing bubble, and it would eventually burst, but the investors figured that they would be able to make there profits and not be effected by a burst. They assumed a risk, in exchange for the potential of higher rates of returns. Professional investors should understand this, but in reality, professional investors saw only upside potential and reacted by seeing other professional investors putting money into these securities, and they didn't want to miss the boat.

Why should these investors now be bailed out by the government for making a poor decision? This will only reinforce this bad behavior.

Now lets look at the people who took out loans that they couldn't afford and are now facing foreclosure. Should they be bailed out? The mortgage documents that they signed clearly spelled out the risks associated with potential rate increases. They knew what there income and expense were (or should have). They could easily figure out what would happen if the interest rates rose, they even had a lawyer present (the closing attorney) to advise them. So why did they enter into the bad contracts. Again, they looked only at the upside potential (we can always resell the house for more money) and they saw their neighbors purchasing larger and larger houses and decided that they didn't want to miss the boat.

Once again, if the government bails them out, it will only reinforce bad behavior.

But what if the government doesn't bail anyone out? Will the economy collapse? I think not. For one thing, the investors will be much more willing to renegotiate the mortgages to make them more affordable to people who really can repay their loans. The profit won't be as high, but it will still be greater than if the mortgage is allowed to go into foreclosure. The people who took out these loans would rather pay a higher rate than they initially assumed that they would, but get to keep their house. Over time things will balance out, and everyone will have learned to look at the downside as well as the upside of contracts in the future.

Let people and corporations take the risks, and let them fail when things don't go right. In the short term there may be some (significant) pain, but in the long term the economy will be healthier for it.