The bank bail-out that some of us said from the beginning would not succeed hasn’t. Now things have moved on, and we’re hearing about making it bigger or simply nationalizing one or more banks.
Now, I proposed a solution a while back, but before I mention it yet again, I’d like to wander off Abe Simpson-like, as meandering through one issue sometimes leads to clarity on another. Long-time readers may recall that for a long time I was a consultant, and I did a lot of work for the military. Now, for a lot of big companies, working for the military can be a sweet deal. Just as a for instance, there’s an aerospace company that has a plant that takes up a few city blocks worth of land in the middle of Los Angeles. Assuming they have the same arrangement now that they did just a few years ago, the land is owned by the US government and they pay rent of $1 a year to use that land. And they don’t even do military work at that particular facility any more; the plant builds pieces for commercial airliners these days (though back in World War 2 it made a very fine fighter plane) but the $1 a year rent has been going on for a long time and the land would be worth a lot more for any other use. (Where are the folks who always howl about rent control?)
Anyway, what I’m getting at is that a historical need (i.e., the need for fighter planes in World War 2) has led some companies getting privileges that continue on and on and on, long after the need for those privileges has disappeared. That’s not to say that the beneficiaries of those privileges can’t find some way to justify them – the plant creates jobs, it ensures the capability is still there to quickly start building bombers should the need arise, yadda yadda, yadda yadda. And of course, because things have always been done that way, well heck, the folks in the military and elsewhere in the government see no problem in continuing things that way. Heck, they have built up a vested interested in continuing things the same way – relationships, future job prospects, etc.
But that doesn’t mean its the way it should be done. And looking at disasters provides a helpful illustration. Consider, for instance, a situation in which a number of the aerospace companies made a big and disastrous bet. Perhaps they assumed they could build plane fuselages out of cow manure and kitty litter. The advantages of such an approach, were it to work, are obvious – cow manure and kitty litter are much more inexpensive to obtain and work with than exotic materials and fancy composites. The disadvantage of such an approach would be equally obvious: if by some miracle you manage to get a a plane with a fuselage made out of cow manure and kitty litter off the ground, it won’t simultaneously a) stay aloft under its own power or b) maintain structural integrity for very long.
Now, let’s say that for whatever reason, a bunch of aerospace companies decided to build planes out of cow manure and kitty litter. A few years later, those companies would find themselves in trouble. And its important to understand – these days, no single company builds a plane. A piece of the fuselage is built here by company X, a piece is built there by company Y, the avionics are assembled by someone else, etc., etc. In other words, there are what on Wall Street one would call “counter party risk.” So not only would the companies that used cow manure and kitty litter be in trouble, other companies that dealt with them would be in trouble. No matter how good your auto pilot software, its useless in a plane built out of bovine and feline waste.
So should these companies be bailed out? Well, no. The companies that chose to use kitty litter and cow manure made a stupid decision, and should be forced to live with it. What about the counterparties? Well, they shouldn’t be bailed out either – it should be part of their job to ensure they’re dealing with reasonable partners. Hitch a ride to a winning partner and you make off like a bandit; hitch a ride to a losing partner and lose. And if they have no way to verify whether that’s true, perhaps they’re in a business they shouldn’t be in in the first place.
And if these companies go bankrupt, its not the end of the aerospace industry. The parts of these companies that are functional would be scooped up by other companies, provided they were deemed to serve some useful function going forward.
I think few people would disagree with me in this extreme example. But the example also brings up one other thing – a disaster like this would provide an opportunity to revisit the subsidies the aerospace companies are receiving. $1 a year for a few blocks of prime space in Los Angeles is simply welfare, and is the kind of detail that would probably come into the light uncomfortably if aerospace companies were in trouble for building planes out of cow manure and kitty litter. Public outrage might have led to the death of these giveaways.
So back to the financial industry and the real world – its clearly a parallel to the aerospace industry in my little fable. But what’s the counterpart in the story to the $1 a year in rent, the one part of my aerospace industry fable that is actually true? Well, that’s easy – its the subsidy that comes from monopoly access to the Federal Reserve. The banks can deal directly with the Fed – you can only deal with the Fed indirectly through the banks, which take a cut as middlemen.
And the solution to the whole financial mess is the same as the solution in my little fable: let the companies that made bad decisions fail, and end the subsidies the industry receives. In other words, let the bad banks die, let their counterparties die as they made equally bad decisions (its not like companies in just about any industry aren’t able to figure out in many cases who their riskiest counterparties are, regardless of the industry they’re in, as per this piece by Yves Smith), and end the banking industry’s monopoly access to the Fed. A lot of banks will go bankrupt – after all, being a middleman is relatively easy work. But a) its unfair and b) inefficient.
Following this approach would lead to some term pain – a lot of it in fact, but that pain is going to be there no matter what approach we take, and that goes doubly so for the silly and counterproductive plan pursued first by the Bush and now Obama administrations. But in the long run, bringing the banking system into some semblance of capitalism will make everyone better off… except the grifters.