Government bailouts and special loans in a free-enterprise system

TOPIC: Major financial institutions, manufacturing corporations, and other businesses often receive millions or even billions in financial help from governments, as bailouts or special loans. But why should taxpayers come to the aid of companies in a free-enterprise system? Discuss, concentrating on some specific company or companies, or industry.

Nobody could argue with the “too-big-to-fail” concept of financial institutions and corporations being so large and interconnected that their success (and failure) has an extensive ripple effect on the overall economy. Therefore, governments award bailouts or special loans to those firms as an alternative to economic depression that would let citizens suffer the consequences of unemployment, loss of revenue and the diminishing standards of living. When Lehman Brothers went bankrupt in September 2008, it became clear that the biggest financial firms were so interconnected and powerful that only bailouts would save the financial sector from collapse. Should large corporations have the opportunity to hold that much power over the world economy or to have control over the standard of living of masses? Has “the current industry structure enhanced social welfare or served a detrimental role?” (Acharya et al., 2013) This essay will examine the social value and ethical implications of the current financial sector and the government subsidies that support it. I personally believe it is wrong to support the richest and largest corporations in the world with taxpayer money when it perpetuates the inequality between the rich and the poor (and now middle class). Maintaining the high wages and enormous bonuses to top executives and keeping them into the top 1% of the world’s wealthiest people after their firms were just on the verge of bankruptcy gets my blood boiling. It seems unfair to indulge in the “winner take all” perspective of our society and limiting the opportunities for regular businesspeople that just want to increase their market share but get swallowed whole by the bigger players. We can also point out that bailouts and loans from the governments largely implicate them in business and intercedes the dynamics of a free-enterprise system. However, the problem may revolve more around the actions and financial structures that bring about public financial support to major companies and not the bailouts themselves. I will discuss some facts, my point of view on them and how it might be, in some cases, narrow minded in terms of the big picture and the longer term health of our economies. This will be done through the presentation of principles, ideas and real examples of this subject and some commentators’ points of views.

Some Real Bailouts

The latest wave of government bailouts took place during the late 2000’s global economic crisis. It brought about $700 billion in total bailouts in the United States. Major financial institutions as Bear Stearns, AIG insurance company or Fannie Mae and Freddie Mac were rescued to minimize the effects of the economic collapse that occurred after the Lehman Brothers bankruptcy. AIG, for example, was a seller of what we call credit default swaps, a kind of insurance policy on bond defaults (such as subprime mortgages). Many other financial institutions had bought these swaps and AIG’s eventual financial trouble would backfire on all of them, making their interconnection dangerous for a series of bankruptcies. When the housing market came crashing down, subprime mortgages became defaults and the mortgage-backed securities such as swaps were difficult to value and many claims came in. AIG did not have the liquidity to cover the swaps and the Federal Reserve of the United States came in to help with a $85 billion loan for 80% of ownership equity. Their bankruptcy would have been too risky for the global economy. After this bailout, AIG awarded $165 million in executive bonuses in order for executive retention to make sure they would unwind the credit default swaps situation. (Amadeo, 2017) This outraged many spectators of the crisis and taxpayers, but was made to be a necessary evil. This story feels frustrating because AIG took unnecessary risks and followed many financial institutions into the housing bubble that eventually burst and put the whole economy into recession and jeopardized many people’s livelihoods. The positive from this was the $23 billion profit that the government made for taxpayers when it sold its majority stocks of AIG in 2012.

The bailouts also spread to the manufacturing industry and the most talked about industry in the media was without a doubt, the automobile industry. The Big Three American automakers (GM, Chrysler & Ford) were bailed out for $80.7 billion from the Troubled Asset Relief Program to prevent their bankruptcy, the decrease in economic output and the loss of 1 million jobs. The automakers were nationalized in 2009 by the United States Government, giving them ownership stakes. On December 18, 2014, the Treasury Department ended the bailout and sold its last shares of Ally Financial (formerly GMAC), at a $2.4 billion profit for taxpayers. The overall investment in the Big Three automakers was at a $10.2 billion loss after recovering its assets, but the American auto industry has recovered and is thriving today. GM and Chrysler, as well as their dependents along the supply chain were saved in the process. (Amadeo, 2018) The auto industry bailout is a different story from the financial system rescue. If the government had let these companies go under, the economy might not have been worse for it because competitors could have taken over their market shares, such as Honda or Toyota. The American people might have been upset to lose their heritage but the overall economy would have survived with similar output and jobs, just from different sources.

Bailouts: Why They Are Wrong, Why They Were Necessary

In light of the previous situations, we can see how many factors can be examined around government financial help to large institutions, but is this privileged treatment an ethical thing to do in the first place? Even if taxpayers were lucky this time and the industry picked up and mostly warranted them a return on their investment (Duggan, 2017), should the government take this risk? With hindsight, it is easy to argue the effectiveness of government bailouts, but the financial health of corporations is difficult to predict. The bailouts seemed necessary at the time, being more effective than a disorderly liquidation of bankrupted firms, but they remain a gamble, a bet that the US government took to prevent corporate irresponsibility from breaking the financial system. The companies could have not recovered and gone bankrupted regardless if not enough changes to their operations and risky behavior were made. Some regulations and standards were conditions of the bailouts for safety, but the oversight could have also failed to improve their situations. Those who paid the bills of the bailouts did not receive actual explicit government services for their investments (i.e. police, healthcare, etc.), so the government better always make sure never to misdirect funds to be wasted into gamble investments. It is also pertinent to wonder where the government of the United States found the funds to finance the 2009 bailouts; which public service or other expenses did they have to cut funds to in order to respond to the economic crisis? Continuing bailouts enslaves taxpayers to the big banks or large corporations that control the world.

Furthermore, I believe the financial help provided by the governments to too-big-to-fail companies creates an uneven playing field and an unfair business environment, benefiting large companies and leaving out the small ones. It also promotes barriers for true market competition and diversity in the financial system. The larger corporations increase their market shares to the detriment of smaller firms. As this persists, larger firms become even larger and wealthier which penalizes the small ones and limits their opportunity for growth. The free-enterprise system is based on a competitive environment that doesn’t allow for abuses of monopoly or oligopoly. “Competitive markets means that there exists a large number of buyers and sellers where no one is large enough to significantly influence the market price by his actions alone.” (Allen, Armstrong, & Wolken, 2018) The power of the too-big-to-fail and their government funded financial help is contradicting this principle with unfair treatment. During the financial crisis, most businesses suffered, including the small family businesses that are at the essence of our society. According to the Business Journals of U.S. Census Bureau, more than 170,000 small businesses had to close between 2008 and 2010, in the United States (Thomas, 2012) and could not benefit from public financial bailouts.

In fact, institutions that recognize their status as “too-big-to-fail” could use the opportunity to take larger risks with the government’s implicit financial support as a backup. This would reduce the discipline of the financial sector and increase reckless behavior that could endanger the economy. Personally, although the bailouts of the economic crisis helped the financial system survive and the economy recover, I believe that it let the financial institutions and large corporations get away with the large risks they took without any major consequences. They felt protected by their status. After the government rescue, they failed to hold the bailed out institutions accountable for getting into trouble in the first place; banks gamble with clients’ money and they are almost too big and powerful to prosecute. The government could have let them