The Ethics of Government Bailouts

I woke up this morning to a headline on MSNBC that said that the Obama administration fears a populist backlash against the bailout plan. This, in light of the fact that AIG, a company that has so far collected $170 billion in government bailout money has, nonetheless, decided to give its executives $160 million in bonuses.

See: MSNBC, White House bracing for a bailout backlash

I worry that this backlash may be the case of mob rule taking over and destroying the very thing the people need to survive – like the drowning man who drowns the person who comes to rescue him.

Let me start with my take on the moral component of this financial crisis and those who are responsible for it.

I think it is stupid for the government to be giving hundreds of billions of dollars to people who have a proven record of destroying hundreds of billions of dollars in wealth. This is like awarding a contract to replace a poorly built dam to the same company that built the first dam.

The government should be saying, "Before you get any of our money, you need to fire the executives responsible for this mess and hire a new crew – a crew that we can trust to handle our bailout money responsibly. It must be a crew that does not have a track record of mismanaging companies."

In other words, the executives who are responsible for this mess should not even be getting a paycheck, let alone bonuses, for their work. They should know life on the unemployment line, where their "previous work history" will help to ensure that they never find another job like their last one.

However, after the Titanic hits the ice berg it is certainly not the case that the first thing to do is to hold a trial to determine if the captain and crew were guilty of negligence. The first thing to do is to save as many people as possible. In the case of the financial crisis, the rule should be to stop the downward spiral first, and punish those responsible when opportunity allows.

The financial crisis hit six months ago – a half a year. The emergency spending bills have been passed. It's time for the government to start showing some judgment in handing out the money to the effect that, "Your company gets no aids if the executives that were running the company a year ago are still in charge. We are not going to hand billions of dollars in taxpayer money over to people who have already proved their incompetence when it comes to running a business."

Another group of people who deserve some measure of punishment are the stock holders. (In some cases, I am included in that group.) The Citibank bailout, where the government took common stock in exchange for bailout funds, is a praiseworthy step in that direction. The shares that the government took diluted the value of all of the shares that existed.

The shareholders are the true owners of a company and, thus, the people who are ultimately responsible for hiring (and firing) the executives that caused this mess. Now, in reality, shareholders have almost no say in the way a company is run these days. However, they do have a say in what companies they will invest in.

As a matter of fact, if a company would have gone bankrupt without a government bailout, then the share value of that company's stock should be listed at zero. Their money is gone. If it is the case that the shares still have value because of a government bailout, then this is the case of the government's money going from the taxpayer to the shareholder’s bank account.

The option of zeroing out the value of existing shares would have the added advantage of allowing the distressed company to raise billions of dollars in private capital (selling new shares of stock) to accompany the billions of dollars in public capital, saving taxpayers billions of dollars.

It will also have the advantage of making businesses properly cautious. People who screw up will actually have to pay for their mistakes - as opposed to the current situation where those who screw up a big company still get to keep their jobs with their seven- and eight-figure salaries and benefits packages, or harvest share value from the tax payer.

Perhaps we need laws for a new type of bankruptcy. Under this law, a company's stock value will be wiped out and new stock will be issued. The executives running the company are fired and replaced by a new batch of executives. Then, the new executives are given government bailout money to try to keep the company (as opposed to the company's owners) afloat, for the sake of the economy.

Once in place, this can serve as the new model for handling government bailouts.

I need a disclaimer on this post. There may be a whole lot of considerations that I have not thought of on this topic. It is to be considered a proposal for consideration, requiring the input of experts in the field. I can argue that there are moral reasons to head in this direction, if only there are no practical roadblocks.