Bailing More than Water

Well it's been one of those weeks in the economy. And while I attempt to stress the importance of everything to my students, I can't help but wonder if any of them get it.

The reality of the situation is very simple: our federal government is bailing out private enterprises faster than Homer Simpson can dunk a donut. It concerns me beyond compare.

To date, the feds have stepped in and assisted Lehman Brothers buy out Bear Stearns, and they've also taken over Fannie Mae and Freddie Mac. As of this writing, there is speculation that they might assist an entity buy out Lehman Brothers. Yes, the same Lehman Brothers that just purchased Bear Stearns about six months ago. The automakers are also asking for $50 billion in government handouts (fortunately, they will probably only get $25 billion.)

Throw in an election year with two candidates that desperately want to win, and it's evident our federal reserve system is really just an ATM (except they don't get to keep the $2.00 fee each time.)

I'm not going to argue whether or not the economy is in dire straits. It is. I don't need Ben Bernake to tell me that and my students don't need me to remind them that their dollar is worth about $.85 compared to last year. That's called inflation.

What I am going to argue, however, is this: I don't think the government should step in and bail ANYONE out - ever.

Get your pencils out for this terribly complex economic/financial formula. Risk = reward. Whew. Got it? Good. Repeat after me. Risk = reward.


So I have to ask you this. Where is the risk to start and mismanage a business if you know the government is going to come in and save the day?

And make no mistake about it. Each of the companies seeking goverment assistance has been horribly mismanaged for years, not just the last few months. Fannie Mae and Freddie Mac epitomize mismanagement, providing deep pockets for Wall Street while simultaneously spending in excess of $150 million in lobbying during the past decade. There is a reason prices of housing escalated so quickly - both agencies allowed consumers to qualify for loans they couldn't afford, with debt ratios in excess of 50% of a homebuyers GROSS income. Think about that for a moment. You make $4000 per month before taxes, utilities, groceries, car insurance, etc. and Fannie Mae tells you to go ahead and take that $2000 per month payment. Where does the rest of the money go?

Throw in the fact that you could purchase a home with $0 down payment (as in ZERO) and you have a recipe for disaster. Nevermind the fact that often the buyer had impaired credit and the seller was paying part, or all, of the closing costs associated with the transaction. Appraised values were inflated, inspections were skewed and sometimes even the real occupancy of the owner came into question. Oh, and everyone made gobs of money.

Even my first year business student recognizes the flaws in this business model. Mismanagement 101, my friend.

So I return to my basic question. Are you willing to kick in the $10-15 BILLION required to bailout Fannie Mae and Freddie Mac?

To be sure, GMAC isn't exactly the model of efficiency and Lehman has been called "greedy" from time to time. They, too, are asking for help.

For argument sake, recognize that we are spending about $10 billion per month on the war on terror in Iraq. Should we rob Peter to pay Paul? That's what we're doing.

How do you pay for these bailouts? There are two ways and neither one is a good option.

1. Alternative revenue sources (political speech for "raise taxes.")
2. Print more money since the value of Treasury Bonds will run more risk than current yields support. If this occurs, something called Hyperinflation will occur and yes, that's worse than it sounds.

There is an answer and it is a painful one.

Allow the markets to take care of themselves. Penalize Fannie, Freddie, GMAC, Lehman and any other company that fails due to mismanagement by letting them become extinct. Yes, it will hurt - bad. But investors will learn their lesson and adjust accordingly. If they don't, they will risk losing on their next investment.

The message being sent right now is "too big to fail." Tell that to Enron, MCI/Worldcom, Adelphia. On the flip side, is Microsoft too big to succeed? We try to break up successful models, calling them a monopoly. Where is the fairness? Is Wal Mart next to be broken up, or are they better of simply running themselves into the ground too?

Risk = reward. If you take big risks, you are entitled to big rewards - or big losses.

You cannot regulate risk any better than you can regulate deman; something communist countries discovered through the black market. And while I don't want to insinuate that we are heading toward communism, we are certainly further away from a free market economy today than we were a mere ten years ago.