Bailout bubble threatens U.S. economy

Pay attention. We are witnessing the inflation of the largest and potentially most devastating economic bubble of our lifetimes. It’s the bailout bubble, and when that bubble pops it could kill the most successful economic system in the world.

First, the federal government decided to bail out fraudulent homebuyers who lied about their incomes to take out home mortgages they couldn’t possibly afford. Then, the federal government bailed out gullible and/or deceitful lenders and Wall Street investors facing gigantic losses because they failed to assess the risks tied to mortgage-backed and asset-backed securities.

Next, it was time to bail out manufacturers of shoddy products that are inefficiently produced. Now, we are told the entire economy needs to be bailed out. On the eve of President-elect Barack Obama’s inauguration, the country appears solidly behind undefined plans to increase federal government spending by hundreds of billions of dollars, perhaps a trillion dollars or more.

In a bailout bubble, no spending request is too small. No amount of inefficiency and waste is ridiculous. “It’s much better to do too much rather than too little. You can always scale back.” Forget about the failures of Great Society “antipoverty” programs such as Aid to Families with Dependent Children, Medicaid and food stamps. Worry later about unsolved social problems like teenage pregnancy and drug abuse. Don’t be bothered when failed government programs worsen such devastating social problems.

We need public works projects to rebuild crumbling infrastructure while creating millions of make-work jobs. Bush administration bailouts failed because they were too small. Bailout failures can only be solved by even bigger and more flamboyant bailouts.

The way to solve problems created by “liar loans” is to reward fraudulent borrowers. If fraudulent homebuyers lie about their incomes to take out mortgages they can’t possibly afford, forgive a large chunk of their indebtedness and refinance with low-interest mortgages backed by the federal government. The way to punish deceitful lenders and gullible Wall Street investors is to cover their losses. The way to cure problems created by enormous and growing leverage among consumers, corporations, and all levels of government is to increase borrowing.

Companies must be rewarded when they are inefficient and produce shoddy products. Prevent misallocated resources from being liquidated and made available to efficient companies that produce products that customers are eager to buy.

Unlike a healthy free market where success is rewarded and failure is punished, we must reverse the process. Take resources away from successful corporations (like Toyota) and give them to failing companies (like GM). In a successful election campaign, politicians like Barack Obama railed against “corporate welfare.” In a buyout bubble there is no corporate welfare. There are only necessary corporate incentives to save the economy. Like other famous economic bubbles, buyout bubbles involve:

1. Irrational behavior. How long will it take Washington to admit that you cannot fix a housing bubble by rewarding bad conduct among borrowers and lenders? Sensible and generally rational people sometimes make foolish and irrational economic decisions. In 1634-1636 at the height of the “tulip mania” in Holland the market price for a single tulip bulb approached $35,000 in present-day dollars. When the bubble burst, tulip prices quickly plunged to less than the present-day equivalent of $1 each. It has long been safe to characterize a $35,000 tulip price as “crazy”; only recently have tech stock investors admitted it was crazy to place billion-dollar valuations on Internet stocks with no revenues.

2. Unfamiliarity with basic economic facts. The economic history of the United States is one of long, steady progress punctuated by short economic recessions. Recessions invigorate the economy by reallocating resources to new and better uses. Between October 1919 and November 2001, there were 17 complete business cycles. The economic expansion that started in November 2001 ended in December 2007. Since 1945, the average duration of each cyclical contraction has been 10 months. The average duration of each cyclical expansion has been 67 months (or five and one-half years).

3. New and untested decision-makers. Most working adults have never experienced a serious economic recession. Like many in Washington, President Obama has no first-hand adult experience with how the economy bounces back from recessions. The last serious U.S. recession lasted 16 month from July 1981 to November 1982 when the unemployment rate hit 10.8 percent. The December 2008 U.S. unemployment rate reached 7.2 percent in the current recession that is now 13 months old.

In 1982, Barack Obama had just transferred from Occidental College in California to Columbia University in New York where he majored in political science. It would be another 22 years before he was elected to the U.S. Senate and another 26 years before he was elected president.

The failed economic policies of the Bush administration have greatly contributed to the economic problems the nation now confronts. Confidence in basic free-market principles has been shattered. We elected Obama as a fresh new face proposing change in which we can all believe. Let’s hope he starts by abandoning the failed Bush administration idea that corporate welfare and government bailouts inspire sound economic decisions. Let’s deflate the bailout bubble before it pops and threatens our free and open society.

– Mark Hirschey is the Anderson W. Chandler Professor of Business at Kansas University.

By Mark Hirschey
January 17, 2009

Source: LJWorld

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