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Wall Street: A Critical Review On Bailouts By Government

Posted in Finance Articles, Total Reads: 3425 , Published on December 14, 2011

The history of slowdowns has been rather interesting. With each one more severe and powerful than the previous, one can wonder what the next bubble will be like. Will it be another realty bubble OR a much touted ‘Bailout bubble’? We don’t know yet but we hope that we don’t get to learn about it the hard way.

Bailout by government

The series of recent slowdowns started with ‘.com bubble’ in late nineties and early 2000s. This was followed by ‘sub-prime crises’ due to policy of ‘American dream home to everyone’, the most severe slowdown since the great depression. The economies in the world came to virtual standstill. This was mainly because of buckling of bigger corporations. The US government had no other option but to bailout these big companies which let to financial bailout package of $700 billion in 2008 (4.9% of GDP).$100 billion given to auto industry would have provided each employee with about $33,000 to search for a new job.

People who have remained silent while bearing the brunt of slowdown have woken up to the fact that the policies taken by the government are not in their favour. Recent ‘Occupy Wall Street’ agitation in the US is the proof. Bourgeois of America calling themselves ‘We are the 99%’ are protesting that their hard earned income is being taxed more than the so called ‘They are the 1%’ (the rich) to bailout the corporations and countries like Greece, Portugal etc. (according to the current trend).

Should the ‘Higher the income lower the tax’ policy be abolished? OR are they carried away by the herd mentality in protesting against the government? We decided to give a thought to this one.

Let’s go back in time. When the Lehmann Brothers collapsed in 2008, several other financial institutions also got into critical state. The entire system is so intertwined that fall of a couple of big companies might cause domino effect and thus bringing down the entire economy. In such a dire situation the government thought that, in short term, the only way out of this mess was to bailout the ailing corporations. So where might the government get the funds from? They couldn’t take more debt as they might cross the debt ceiling. They couldn’t print more currency as this would lead to intolerable inflation. So taxing people’s income was the only option.

In 2008-09 the poor condition of ‘big 3’ of automobile industry in US threatened job loss of over 3,000,000 employees which would have adverse effect on socioeconomic structure. Employment being a critical issue in US political arena, saving jobs was government’s top priority. Interestingly, the bailout of $100 billion given to auto industry would have provided each employee with about $33,000 to search for a new job. Meanwhile, the stimulus was also not directed properly. Funds were given to corporations which did not need them and vice versa. For example, funds were also given to stimulate upscale areas like Beverly Hills, which did not require them.

A company filing bankruptcy is mainly because of its inefficient practices. Bailing out such companies encourages opportunistic and risk taking behaviour. It is like investing in inefficient practices. It creates moral hazard through the assurance of safety nets.

Capitalist theory says that both success and failure must be allowed to happen when they are earned. Government intervention in free market would kill the concept of capitalism. The inefficient entities should be allowed to fall gracefully without spreading contagion.

So the question comes back: Is the bailout necessary? We feel that it is. In a situation of stagnant economy a boost to demand side needs fiscal stimulus while the supply side needs financial aid in form of bailout package. However, it should be more targeted. The funds used to service these companies should be used to increase demand and help these companies to improve their top line. Moreover, the taxation system should be such that there is equitable distribution of taxes and the proceeds are used for developmental activities. This has predominantly been the voice of ‘Occupy Wall Street’.

Anyways the bailout of corporations and countries will not help in long run as the economists like Gerald Celente, Peter Schiff and David Walker say “Even a bigger bubble is awaiting us- ‘The Bailout Bubble’”. But that’s another story.

So we say “Allow the natural regulations and incentives of free markets to decide winners and losers and no the whims of bureaucrats and politicians”.

This article has been authored by Unique Mehta and Vivekanand Modani from NMIMS, Mumbai.

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