Posted on January 28, 2009 - by Venik

Why Bailout Will Not Work, Again

Back in September I wrote a short piece on Bush’s bailout plan – Why Bailout Will Not Work. The bottom line of my rant was: the US economy is so massive and the US national debt is so high that the federal government is just too poor to fix the problem by simply throwing cash at it either in the form of tax cuts or direct financial stimulation of affected industries. The bailout did not work.

The process started by giving taxpayer money to large financial institutions. The logic was simple: a big drop in real estate prices led to the mortgage crisis, which led to the collapse of various pyramid schemes built up by America’s largest lenders, which caused the lenders to stop lending because they ran out of cash, which caused problems for the rest of America’s businesses and consumers, who heavily rely on borrowing for both long-term strategies and short-term survival. And so, the plan went, if we inject enough cash into the lending industry, things will get back to “normal”.

Big banks received their federal handouts and… just sat on the funds. Why? Unlike the federal government, top bankers had a much better grip on the extent of the problem. The federal funds were just enough to keep these banks afloat for another few weeks or months. Once this realization reached Washington, the decision was made to nationalize the country’s largest banking and lending institutions. But just because you nationalized a bank doesn’t mean you suddenly discovered some unlimited source of financing. You are still in a hole. The only difference is that now it is your money being wasted and there is nobody to blame.

The US was not a unique example of such shortsighted logic. Russia injected tens of billions of dollars directly into its banking system, hoping to stimulate lending. The same things happened: banks converted federal funds into foreign currency and gold reserves and just sat on these resources, leaving Putin shaking his fists in silent anger. Because Russian government has a much bigger footprint in the country’s banking sector, government bureaucrats moved quickly (for government bureaucrats) to correct the situation. They created a list of “strategic enterprises” with priority access to bailout money. The lending process was to be handled by the VEB bank – Russia’s equivalent of Fannie and Freddie. At the same time Russian government was forced to abandon micromanagement of the ruble’s exchange rate, which will inevitably lead to higher prices and inflation, but, in combination with drastic reduction of export duties, should also help Russia’s exporters (as well as some importers who buy under long-term ruble-based contracts).

Bush’s bailout plan was criticized for being insufficiently detailed. Obama’s bailout plan is being criticized for being overly elaborate. Congressmen and Senators complain that reading all 650 pages of the new bailout plan is just too much work and that concepts contained in the document are too technical and difficult to understand. If you ask me, this is a ridiculous complaint from a bunch of freeloaders, most of whom are trained lawyers and economists. A quick advise to our distinguished legislators: pool your money together and hire someone to read the plan and write you some Cliffs notes. This will be like finals time at Yale all over again.

Opinions regarding the bailout plan can be shoveled into two piles: Cut-Taxes-And-Give-Money-To-The-People and More-Federal-Spending-Because-The-Government-Knows-Best. Personally, I will stick with my previous assertion that the government is too poor to fix the economy. Therefore, it really doesn’t matter how it spends the available funds – the end result will be equally unimpressive. The proposal to cut taxes sounds simple and logical: you put the money directly into the pockets of consumers and small businesses (which create most jobs). This is a straight-forward plan the effect of which will be felt by all Americans almost immediately. This plan also has the added bonus of not being 650 pages long.

Unfortunately, this proposal is based on two big assumptions: a) the tax cut will be deep enough to make a difference; and b) the people and small businesses will use the money immediately to buy goods and services and to create jobs. We really do give ourselves too much credit (in more ways than one). While the total tax cut amount may sound very impressive – tens and even hundreds of billions – once divided by 138,000,000 (the number of taxpayers) or by 30,000,000 (the number of small businesses in the US, according to IRS), the individual payout of such a bailout plan will not be particularly awe-inspiring. Numerous opinion polls also show that most people and small business owners – should they receive any tax cuts from the government – are likely to save the money or pay off the bills, instead of buying things and creating jobs. So where would most of these federal tax cuts end up? Probably in our recently-nationalized banks and back in the government’s hands. And so, what would be the point of this exercise? Besides, we already had a tax cut last February with no noticeable impact on our deteriorating economy.

The other idea, of course, is to have the federal government spend the money on various infrastructure projects in an attempt to create jobs and invest in our future needs. Once again, there is just not enough cash for the government to offset all the recent and ongoing job losses. On top of this, a considerable portion of allocated funding inevitably will be wasted by inefficient government bureaucracy. Still, this approach gives the economy some hope – not so much by creating actual jobs and restoring  incomes, but primarily by helping to maintain appearances of a bustling economy. You know, sometimes looking good makes you feel good and makes others feel confident in your abilities. Sort of like when you interview for a job you are under-qualified for, but you get the position anyway because you are well-spoken, wear an expensive suit and drive a flashy car. People have a hard time imagining that someone so sharp-looking can be an idiot.

I voted for Obama and I continue supporting him and his bailout plan. On the other hand, I try to remain realistic: Obama just doesn’t have the money to save our economy. Sure, the government can borrow more – it has to borrow more regardless of whether we take the path of tax cuts or infrastructure projects – as we are already beyond the point where we could ever repay our debts and so how’s another trillion or two of debt is going to hurt us? I think we should buy an expensive suit and a flashy car and hope we start feeling good about ourselves again and, hopefully, convince the rest of the world that we still got it. And then, if by some miracle we manage to fool everybody again, we need to move quickly to make sure that such concepts as “pyramid scheme” and “life without possibility of parole” are closely linked in the minds of our financial movers and shakers. But then again, the game is worth more to these guys than the end result.

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