Sunday Musings: The Failure Of Bailouts

I’ve touched on the potential failure of government bailouts on several occasions. Minyanville examined that issue again in a recent post called “Automakers, Banks Ignore Elephant in the Room:”

So there you have it. The U.S. Treasury this morning said it has committed $6 billion in support of GMAC LLC, the desperately wounded financing arm of General Motors (GM). The move might keep GM out of bankruptcy, and hey, what’s another $6 billion among friends anyway?

Of course, all this talk about bailouts and loan guarantees and avoiding bankruptcy obscures the big question, the elephant in the room as it were, and that’s the underlying demand for automobiles.

The issue, obscured as it is by political motivations and willful misinformation, is actually quite simple. Unfortunately, simplicity has always been Wall Street’s (and politicians’ – the two are now the same) dark secret; there is (was) far more money to be made in taking simple things, such as loaning money to someone to buy a home, and turning them into apparently complex financial structures. So, let’s put it another way.

Ordinarily, when a business/industry fails from poor management and/or (in the case of the banks) overleveraging, what happens? Put aside the issue of what the business/industry is for a moment. Just ask yourself, what happens?

You know what happens intuitively, even if you’ve never opened an economics textbook. It is very simple. Entrepreneurs, seeing the mistakes made by those business/industry operators, rush in to start competing businesses to 1) take advantage of the weakened competition, and 2) operate the business better than the competition having the benefit of seeing their mistakes.

Under normal circumstances, this process happens in every industry. It is the normal cycle of capitalism.

But look at what is happening now. Are there any entrepreneurs setting out to start automotive manufacturing businesses? What about entrepreneurs setting out to charter new banks? You already know the answer to that. The question, then, is why?

First, and most important, it is because the business models within those industries have failed. Second, because the government (taxpayer) has now stepped in to prop up those businesses with their failed business models, it is no longer economically viable for an entrepreneur to try and compete with the government even if the entrepreneur has a better business model. Third, even if it were economically viable, the government is installing roadblocks via the FDIC and other agencies to purposefully make it difficult for entrepreneurs to compete against the failed businesses in those two industries.

Make no mistake, the inevitable outcome will be failure. What is taking place is the extension of that failure to a decade or more. That is what the government is purchasing with the bailout monies; an extension, life support, even though death is inevitable. Why? Why would government do this? Because those who are demanding the monies and the extensions have more political clout than you do.

I have referred to this as postponing economic pain. Propping up failed businesses and turning them into zombie corporations reminds me very much of the former communistic East Germany, where I grew up. Companies were kept alive via government intervention for many years until the system eventually collapsed.

Instead of letting the free market function on its own, and taking the pain right now, we are mortgaging future generations in the hope that this current crisis can be solved by simply throwing money at it. As the above article pointed out, the inevitable outcome will be failure; we just don’t know the timing of it.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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