Ed Lotterman: The least bad bailout

December 20, 2013 

On Dec. 9, the U.S. Treasury sold off the last block of stock it held in the "new" General Motors, thus ending one facet of the private company bailouts stemming from the financial debacle that unfurled in 2007-2008 and still looms over the global economy.

In cash accounting terms, ignoring risk and time-value of money, the U.S. government lost only $10 billion, so the outcome might have been worse. But was this bailout good economic policy, and how will the fact that it happened shape future policies?

GM's bankruptcy and the "bailout" are complicated, and the early stages predated the financial crisis. The corporation's finances had been deteriorating for years. It first sought federal funds in 2006, well before the crisis, but without success. In November 2008, it returned to Congress together with Ford and Chrysler, but again with no success.

However, in December of that year, the Bush administration loaned it nearly $18 billion from the TARP monies originally appropriated to implement financial firm restructurings. President Bush also endorsed the idea of an "orderly bankruptcy" under the terms of Chapter 11, but with participation and financial support of the federal government. That was implemented by the Obama administration starting some five weeks after the new president was inaugurated.

The final deal included the Treasury putting in $49.5 billion and ending up with 60.8 percent of the stock in the new company. (Existing shareholders were wiped out.) No one knows what the outcome would have been had the government not gotten involved. Indeed, that unknown is the key issue in determining whether the bailout was good public policy. But many knowledgeable observers argue that government pressure resulted in substantially better terms for the unions and worse ones for bondholders than would have been reached in an arms-length bankruptcy. (While Wikipedia is not authoritative, its entry on "General Motors Chapter 11 reorganization" gives a good summary of the history of events and key issues.)

So was this government action good policy or not? Economists across the political spectrum and contending schools of thought within the discipline generally would argue that government bailouts of private corporations generally are bad policy. They reallocate resources in economically inefficient ways; they tend to be rife with groups using political power to capture pots of money from others, and they create "moral hazard," incentives for other companies to engage in risky behavior in the future in the expectation that if things don't turn out well, the government will step in to clean up the mess. I agree with this consensus view.

However, what may be true in general is not necessarily true in every specific case. The situation our country found itself in from the spring of 2008 through the fall of 2009 was a highly unusual one. This leads some economists who oppose bailouts in general to support this particular one, not as a good policy but as the least bad one available to the Bush and Obama administrations.

Their argument is that a bankruptcy without government participation at a time when the economy teetered on the brink of an economic abyss could have spiraled out of control and pushed the country into depression.

In their view, there was a high probability GM would run into such cash-flow problems or that its suppliers and financiers would face such uncertainty so as to balk and force it to shut down, lay off its entire workforce and stop buying components. The effects would ripple through the chain of suppliers and distributors.

Collectively, these groups were so large that it would poison the entire economy. GM would no longer be a "going concern," and the bankruptcy would end up being a liquidation, with a tremendous loss of value as assets were sold off piecemeal. Everyone would suffer — not only the shareholders, who were toast in any case, but also the bondholders, employees, retirees and any main-street businesses in regions where GM had plants. The entire U.S. economy would receive a blow at a time of the worst vulnerability in 80 years.

Critics argue that these fears were overblown, that GM would have kept operating through a Chapter 11 bankruptcy just as well without government interference as with it. There would have been a fairer outcome in terms of the distribution of losses between bondholders and union members, but otherwise things would have proceeded pretty much as they did, without any negative spillovers to the broader economy. And the Treasury would have saved billions of dollars and not established a precedent laden with moral hazard that would motivate future irresponsibility.

No one knows which scenario would have played out in the absence of government action. Republicans in Congress clearly were not prepared to act, although more might have chosen to vote for some action if a president of their party had not come up with the gambit of using TARP funds already appropriated and if GM's situation had gotten closer to spiraling out of control.

But George W. Bush's administration clearly was frightened by the prospect of a messy collapse of GM, as was that of Barack Obama after the inauguration. As for the takeover of AIG and the "take this money or else" initial TARP disbursements to 13 large banks, the Bush administration's choice was to err on the side of being safe rather than sorry, even if it established terrible precedents and incurred large Treasury outlays. And as with the other bailouts, the Obama administration chose to continue virtually the same policies.

I think this was the closest call of any decision made during the critical six months of October 2008 through March 2009. At the time, I was skeptical of the deal but wrote columns calling it the least bad option available. I still think that's true. But this is one economists and historians will argue over for decades.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

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