Does America have the bailout monkey on its back?
So far this year, the federal government has put up nearly $30 billion to avert a major financial default by the investment bank Bear Stearns; committed to investing up to as much as $200 billion in preferred stock of the loss-plagued finance giants Fannie Mae and Freddie Mac and at least $5 billion in their mortgage securities; and agreed to provide an emergency loan of $85 billion to American International Group Inc. in return for an ownership stake of as much as 80 percent in the stricken insurance giant.
Tuesday's helping hand to AIG bailed out not only that company, which was contemplating a bankruptcy filing as early as Wednesday, but also countless trading partners of the company, including investment banks that had failed to raise the massive loans themselves.
Thus far, only one major supplicant for federal assistance has been turned away: investment bank Lehman Bros. Holdings Inc., which was refused a bailout by Treasury Secretary Henry M. Paulson last weekend and filed for bankruptcy protection Monday. Meanwhile, Congress is contemplating a loan program of $25 billion to $50 billion for automakers.
This year's bailouts add up to an unprecedented surge of direct financial intervention by the government in the nation's private sector -- a cornucopia of handouts and guarantees dwarfing the rescue of the savings and loan industry in the 1980s, which ended up costing taxpayers $124 billion.
Lessons from a bailout
In each case, industry and government officials have justified the bailout as cheaper in the long run than doing nothing. But critics contend that bailouts often encourage bad behavior by relieving underperforming industries of the consequences of their ineptitude. In addition, sometimes the government can end up as an investor in companies that are the target of regulatory action, creating a conflict of interest. The government's potential ownership of AIG could put policymakers at cross purposes with their own efforts to regulate a variety of financial transactions in which the company participates.
The situation is bound to raise thorny policy issues for the next president, who is likely to face further demands for assistance from mortgage lenders, home builders, automakers and other struggling industries. Economic and legal experts say Congress and regulators need a set of standards for how to treat industries and companies with their hands out, especially when the requests come in an atmosphere of crisis.
"The more the government steps in, the more there are people who want the government to step in," says Peter J. Wallison, a research fellow at the American Enterprise Institute and a former White House and Treasury Department official. "Every time you do it, that creates an equitable argument for someone else to get bailed out."
The president and Congress also will have to decide what sort of concessions to demand from recipients of public largesse. For example, only days after the Treasury Department announced the bailout of Fannie Mae and Freddie Mac this month, several Senate Democrats proposed that the mortgage companies freeze foreclosures for at least 90 days.
Auto industry in line for help
A loan guarantee package for the auto industry is likely to be one of the most closely watched measures in Congress this year. U.S. automakers contend that financial help is warranted because the cost of redesigning their products to meet federally mandated mileage standards by a 2020 deadline will be staggering.
That could provide a template for a similar appeal from airlines, which could argue that the cost of fuel and security measures are hobbling them.
Without more open rules governing the decision-making process, the entities with the most potent lobbyists may get bailouts, putting competitors at a disadvantage.
"We don't have any rules about whether the government should get involved or not," says Cheryl Block, a law professor at Washington University in St. Louis who has followed the bailout issue since the 1990s."Certain things happen in the middle of the night, and no one knows who's in the meeting."
'Too big to fail'
For now, the decisions seem to be based on a sense that an entity is "too big to fail."
Such concerns drove the bailout of Fannie Mae and Freddie Mac, which together back half of all U.S. residential mortgages. Their failure, government officials feared, could choke off the supply of mortgage credit or drive up mortgage interest rates to levels that would impede recovery for the country's beleaguered housing market.
"Fannie and Freddie define what's too big to fail,' " says Jared Bernstein, an economist at the Economic Policy Institute.
A similar case could be made for a company such as General Motors Corp. More than 250,000 workers and roughly 500,000 retirees worldwide are dependent to some degree on the survival of GM; a bankruptcy filing would throw many workers on the street and could deprive thousands of families of health coverage. It also could further strain the federal Pension Benefits Guarantee Corp., which insures retirement benefits and already has a $13-billion deficit.
But a company need not be the biggest in its industry to pass the "too big to fail" test. Bear Stearns was the nation's fifth-ranked investment bank in terms of assets when the Federal Reserve and the Treasury arranged its emergency sale to JPMorgan Chase & Co. in March. Bear's deal-making, though, extended deeply into the financial derivatives markets, raising fears that its sudden collapse would produce a tidal wave of defaults around the globe, shattering the confidence necessary to keep the international credit markets functioning smoothly.
The interventions surrounding Bear and Fannie/Freddie suggest that government officials have been fairly successful at distinguishing cases where a company's failure would have broad "systemic risk," and acting only in those cases, says Laurent Jacque, professor of international finance and banking at Tufts University.
Influence of Presidential campaign
Presidential politics may be driving the recent rush toward government assistance. In June, Republican candidate Sen. John McCain drew a line against the auto industry bailouts during an appearance in Ohio, saying, "I just don't see a scenario where the federal government would come in and bail out any industry in America today."
As Michigan's importance as a swing state in the presidential race grew, however, McCain changed his tune. In August he proclaimed, "We should fund (the loan program) and take action that will assist Detroit and its suppliers in making it through this difficult time of transition."
Democratic candidate Sen. Barack Obama also supports the auto loans.
Some experts fear that that government investments in the open market could artificially support market prices, thus creating a "moral hazard" that investors will make unduly risky choices, assuming that government intervention will limit their losses.
Putting a floor under the market
That's a concern presented by the Treasury's plan to purchase mortgage-backed securities issued by Fannie Mae and Freddie Mac, and take a large stake in AIG.
"They're essentially saying they're going to put a floor under the market," says John Lapp, a professor of economics at North Carolina State University. "That's just begging for excessive risk-taking."
Others say that bailouts can be good medicine for ailing industries, particularly when they're coupled with strong incentives to improve. It is widely assumed in Washington that the financial-industry bailouts will lead to tighter regulation of investment banks.
On occasion, the government may turn a profit on a bailout. Chrysler's recovery netted Uncle Sam about $300 million when warrants the Treasury received in return for the loan guarantees ended up in the black.
Wednesday, September 17, 2008
A discussion about the crisis on Wall Street with Lawrence Summers, Andrew Ross Sorkin of The New York Times Charles Gasparino of CNBC, Josh Rosner of Graham Fisher & Co. and Nouriel Roubini. Lehman Brothers, the fourth-largest US investment bank, has filed for bankruptcy protection, stock markets and the US dollar have tumbled in reaction to Lehman's collapse.
William Tucker’s The Case for Terrestrial (a.k.a. Nuclear) Energy, appearing in the August 2008 edition of the Whistleblower, makes a strong and encouraging argument for nuclear energy. Tucker argues that nuclear technologies are more sustainable and less polluting than fossil fuel bases. They are also more productively viable than wind, solar and hydroelectric alternatives. According to an Energy Information Agency assessment, nuclear technology is also the least expensive of all energy options (note: hydroelectric power is less expensive than nuclear, but it requires specific geographic conditions to be viable, while nuclear facilities do not).
While our coal industry is homegrown and may be sustainable for some time, our oil industry is not. There is serious contention from industry and resource experts that worldwide petroleum reserves are diminishing. Furthermore, the vast majority of American oil consumption is fed from foreign suppliers.
The United States' domestic production meets roughly one fourth of its daily consumption. The remaining petroleum is purchased from foreign entities at exorbitant prices. This practice has indebted America, it has shipped hundreds of billions of hard-earned dollars overseas, and it has contributed to ruthless regimes that are often antagonistic to the U.S. and its interests.
There are many ways to break our dependence on oil, but there is no cure-all, no “silver bullet” waiting to be deployed. America must develop domestic alternative industries and it must do so immediately before it is too late. A major part of the solution could and should be nuclear energy.
Nuclear energy already produces about 20 percent of American electricity. The majority of our electricity is coal-fired. Coal-fired plants notoriously cause pollution, while nuclear plants emit no air, water or ground pollution. With the right commitment to rebuilding the long-ignored nuclear infrastructure, we could completely switch our electrical grid to non-polluting sources.
Currently, 70 percent of our oil-derived energy is used for transportation, while only 2 percent is used for electricity. But nuclear energy has much more energetic capacity than any other human technology. Using Einstein’s famous mass-energy equivalence E=mc2 we see that the fission of a single atom of uranium-235 (“enriched uranium”) is 100 million times more energetic than the combustion of a single carbon atom.
This incredible energetic capacity makes nuclear energy a fitting oil-substitute for transportation. It would not only be able to meet our current electrical needs, but could also be used to produce the power necessary for a fleet of electric automobiles. Nuclear power supplies produce constant energy 24 hours per day, unlike wind and solar which depend on weather and time of day. Electric energy is used less at night than during the day, and this time could be utilized by nuclear facilities to direct their electrical generation into producing hydrogen for next-generation hydrogen fuel-cell vehicles.
It has been well documented that nuclear power is incredibly safe and reasonably economical, yet there is still a stigma surrounding nuclear contamination. Of the 443 active nuclear facilities in the world, 103 of which are operational in the U.S., there have only been two major safety lapses which could have endangered the public: Three Mile Island and Chernobyl.
The accident at Three Mile Island resulted in a partial meltdown of a small portion of the reactor core. An unknown amount of radiation was released into the air, but according to the Nuclear Regulatory Commission’s assessment, the local population would have received no more than the equivalent of a chest x-ray.
Chernobyl on the other hand was a major catastrophe in which the reactor housing exploded, and released large amounts of radiation into the air. Several people died in the explosion, and some workers suffered fatal radiation exposure during the clean-up. The surrounding area was also highly contaminated (as Tucker points out, residents of Pennsylvania received more radiation from Chernobyl, Ukraine than from Three Mile Island).
These instances are absolutely exceptions to the general rule. The only major disaster resulted from a combination of poor management, training and construction on the part of the Soviet Union. A new generation of reactors would have higher safety standards than any currently in operation. The opportunity for research and development in this field is enormous, and it carries the potential of renewing America to prominence in a field that it once commanded.
Another problem with nuclear energy is waste. Nuclear waste is some of the most poisonous and toxic material in the world, but under current regulations it is incredibly secure. The Nuclear Regulatory Commission, International Atomic Energy Agency and Department of Energy all simultaneously oversee its storage, disposal and recycling. Nuclear waste is transmuted into metal rods or glass pellets, neither of which dissolve in water, and then stored in metal tubes. These tubes are further encased in casks made of reinforced concrete and steel which are then filled with water. They are nearly impossible to compromise, making the threat of terrorism or other malfeasance unlikely. Long-term storage of nuclear waste material is highly contentious but there are many viable options well within the scope of current engineering.
Nuclear energy is sustainable far beyond the most optimistic outlook for oil reserves. It is economical, and it requires an investment of technological research necessary to spur America’s lagging economy. The Nuclear Age began in the U.S., but the process has been held hostage by fear-mongering for decades. It is time to right this wrong and renew our commitment to nuclear energy.