The Greatest Payoff in World History — And Just the Beginning

By Ken Schoolland and Mats Walus

Ken Schoolland is a Hawaii Pacific University professor of economics, the author of award winning novel, The Adventures of Jonathan Gullible, and is on the Board of Directors of the International Society for Individual Liberty. Mats Walus is a member, of the International Society for Individual Liberty.

President Obama declared on the CBS “60 Minutes” television show, “I did not run for office to be helping out a bunch of fat cat bankers on Wall Street.” Really, Mr. President? Then why did you accept $38 million in campaign contributions from those “fat cats” in the industry?[1]

All the major Democratic and Republican presidential contenders supported the Toxic Asset Relief Program (TARP) as passed by Congress in September of 2008. Soon after passage, the package was miraculously transformed from $700 billion in mortgage relief for homeowners to a banker bailout program. This was only the tip of the iceberg. The spending surged to $1.5 trillion under President Obama with estimates of bailout guarantees ranging up to $8 trillion, twice the inflation adjusted cost of World War II.

The Iron Triangle: Special Interests, Politicians, & the Bureaucratic Payoff

The 2008 campaign season was also marked by the largest ever flood of money into politics, nearly half a billion dollars from the finance, insurance, and real estate industry alone. Money from this industry was the most from any sector of the economy and was distributed in roughly equal proportions to Democrats and Republicans.

The 161 companies receiving $305 billion in the original TARP bailout funds made campaign contributions and lobbying expenses totaling $114,000,000 to all candidates. That works out to more than $2600 of bailout funds for each $1 of political expenses in the 2007-2008 electoral season.

4 Most of these contributors are banks and investment houses. They know that there is no better investment anywhere in the world than a well-placed politician.

Bankruptcy vs. Bailout

So what’s the problem with a bailout? Wasn’t it necessary to rescue the financial system from collapse? Despite the hype, this was not the message from the World Economic Forum, a Swiss think tank.

The World Economic Forum ranked the United States as number one in the world for financial strength, the same month that Congress passed the TARP. In September 2008 the U.S. was listed as top of the world for the “strength of their financial markets, and the depth and breadth of access to capital and financial services. This wide-ranging index takes into account the quality of each country’s financial laws and regulations, its business environment, and the likelihood of a financial crisis…” [5]

Why such diverging views about a potential crisis in America? The World Economic Forum was expecting that financial troubles would be handled by well-established laws and regulations. Financial assets don’t disappear. Instead, bankruptcy proceedings transfer assets from incompetent owners and managers to competent owners and managers.

But the World Economic Forum didn’t count on Congress intervening to trash the bankruptcy laws in order to rescue their benefactors with massive taxpayer bailouts. Of course any incompetent owners and managers can be made to look good with a handout of $10-$40 billion. And, in the case of the Federal Reserve Board, there’s nothing that a trillion newly printed dollars can’t patch up…at least temporarily.[6]

The Revolving Door

This bailout was also manipulated by the “Revolving Door” of Washington. This is the constant movement of personnel back and forth across financial, political, and bureaucratic lines.

For instance, President Bill Clinton’s Secretary of the Treasury, Robert Rubin, had previously been the CEO of Goldman Sachs. As Secretary of the Treasury in 1995, Rubin engineered a bailout of the Mexican government that rescued substantial Goldman Sachs investments. President George Bush’s Secretary of the Treasury, Henry Paulson, had previously been the CEO of Goldman Sachs. As Secretary of the Treasury in 2008, Paulson engineered a bailout of AIG and Morgan Stanley that rescued substantial Goldman Sachs investments.[7]

President Barack Obama’s Director of the National Economic Council is Larry Summers. The Honolulu Star-Bulletin detailed speaking fees from Goldman Sachs, Citigroup, and others under the headline: “Firms that got bailouts paid Summers millions.”[8]

TARP companies that were the most foolhardy in taking on risk paid their CEO’s incomes that exceeded the average of all companies in America, of all banks in America, and even exceeded the average of all financial institutions in America. The pay for CEO’s of these TARP companies was well above the industry average both before and during the financial crisis.

Goldman Sachs, for instance, reported a doubling of compensation to its employees in 2009. Compensation to its 21,847 employees averaged $743,112 each.9 Is this the behavior of a company that has just barely survived a reckless disaster? Or is this the behavior of a company that has just scored a bountiful coup?

Moral Hazard

Success and failure are both essential to a thriving free market. Success must be rewarded as a signal to do ever more. Failure must be penalized as a warning to give it up and to try something else. But what happens when these signals are reversed—when success is penalized by taxes that are used to reward failure? Then failure is encouraged to do ever more and success is told to give it up. This is a prescription for certain economic collapse.

The causes of the current crisis have not been rectified. Most of the same people are still in charge and have not suffered for their blunders. TARP company revenues and compensation continue to rise, Congress remains unscathed and ever more strident, presidential powers are massively increased, government agencies are all intact and scheduled for expansion of regulatory authority, and Ben Bernanke, Chairman of the Federal Reserve Board, has been reappointed and is soon to be reconfirmed.

This is the essence of moral hazard. Moral hazard exists when governments intervene in markets to socialize losses. Thus, reckless risk taking is encouraged rather than punished. So the risk takers chuckle, take their bonuses, pay off their political enablers, and do it all over again on a bigger scale the next time around.

The U.S. government bailed out the savings and loan industry in the 1980’s, Long Term Capital Management in the 1990’s, and Fannie Mae, Freddie Mac, GM, Chrysler, AIG, and a host of others in 2008. Each time officials swore that the lessons had been learned and it couldn’t happen again.

On a global scale the U.S. taxpayer has paid directly or indirectly through the Federal Reserve Board and the International Monetary Fund for the rescue of Mexico, Russia, Brazil, Korea, Thailand, Indonesia, and a multitude of other countries. The numbers mounted over the years from $4 billion, $23 billion, $40 billion, and now trillions of dollars. What’s next?

Make no mistake about it, with such perverse incentives the disaster will be greater each time—until Atlas shrugs.

“Never expect the people who caused a problem to solve it.” –Albert Einstein

REFERENCES

  • Finance, insurance, real estate campaign contributions 2007-08 by presidential candidate, http://www.OpenSecrets.org; Glassman, James, “The Hazard of Moral Hazard,” Commentary, 9/09, p. 28-32
  • “How Our Spending Stacks Up,” Time, 12-22-08
  • Campaign contributions by category 2007-08 to all Democrats and Republican candidates http://www.OpenSecrets.org
  • 4) Ebeling, Richard, “Bank Bailouts are the Payback for Bankrolling Politicians,” American Institute for Economic Research, 2-23-09, http://www.aier.org/research/commentaries/1186-bank-bailouts-are-the-payback-for-bankrolling-politicians
  • 5) “Financial Development Index,” The Economist, 9/18/08
  • 6) Monetary base of the Federal Reserve Board. 1959-2009.
  • 7) Sorkin, Andrew Ross, Too Big to Fail, Viking Press, pre-release excerpted in Vogue, 11/09, p. 181
  • 8) “Firms that got bailed out had paid Summers millions,” The Honolulu Star-Bulletin, 4-5-09
  • 9) “3 banks prepared to pay record $29.7B in bonuses,” The Wall Street Journal, 10-14-09

About the author

Ken Schoolland wrote 3 articles on this blog.