Are government interventions the first steps towards corruption & inefficiencies?

January 27th, 2009

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The global financial crisis (GFC) has seen governments all over the world engaging in stimulus, special plans, guarantees, rescues, bailouts, nationalisation and other forms of interventions. The Australian government is no different. The first was the guarantee of all Australian bank deposits and loans. Next was the AU$10 billion economic stimulus. Then recently, there was a plan to set up a special purpose fund to help banks refinance as much as AU$75 billion worth of loans. Other plans include help for certain industries (e.g. car, construction, child-care, property sectors) cope with the global shortage of money (credit crisis). In addition, the Reserve Bank of Australia (RBA) is busy cutting interest rates. In the US and Britain, massive banks and GSEs were gobbled up through nationalisations while their limping peers have their incompetence covered by the monetary printing press. As Australia approaches a hard landing (see Realisation of hard landing ahead for Australia), we can expect what happened overseas to happen in Australia.

Among the various forms of government interventions, we have the strongest reservations against bailouts and rescues. While they ease the pain in the short term, they are detrimental to the economy in the long term. While the sting of this GFC may be soothed by each government intervention, there will always be longer term side-effects, many of which will be unintended and initially unforeseen. All these unintended side-effects will eventually accumulate and turn the GFC into a long-term economic malaise that result in a bleak future for the next generation. In other words, anyone who is concerned for the next generation will have strong reservations for today’s bailouts and rescues.

Here are some of the issues with bailouts and rescues:

Unfairness

They are inherently unfair because the government will have to act as the judge and decide which businesses/industries should live and which ones should die. Unfairness, by its very nature, implies preferential treatment. What is the government’s basis for favouring one business/industry over the other? Due to the ‘emergency’ nature of bailouts and rescues, transparency over such government decisions will be in short supply. This will open the door for corruption as lobby groups and vested interests jostle and fight over the government’s preferential treatment. This is not to say that the current government is corrupt. Instead, our concern is that this will open the door for future governments to be corrupt.

Moral hazards

Bailouts and rescues introduce moral hazards because by not letting the free market punish incompetent, reckless and stupid business behaviours, they are making conditions ripe for more of such nonsense to continue. After all, why bother be good when bad behaviours are not punished?

The whole point of free market capitalism is to let the incompetent businesses be eliminated so that the competent ones can take over the incompetent ones and be rewarded. This competition forces the survival of the fittest and most efficient. By bailing out and rescuing, the government is taking precious economic resources (which is scarce in such a time) from the competent (via taxes) and awarding them to the incompetent. The net result is that the economy as a whole will become more and more inefficient. This is precisely the reason why communism ultimately fails.

Now, there are talks of the need for more government regulations to curb such nonsense in order to prevent future financial crisis. The idea is to bailout and rescue first, then come up with more rules and regulations to ‘prevent’ another global financial hazard from happening again.

The problems with rules and regulations are:

  1. Administering, monitoring and enforcing them are costly. They are a drag on economic growth as they introduce more red tape for businesses to handle.
  2. Rules and regulations may be so effective that while they prevent the bad things from happening, they cab also stifle the good things from bearing fruit too. Those entrepreneurs with brilliant ideas who have to battle government red tape to get their projects moving another step forward can relate to that.
  3. As we said before in Where do we go from here? A journalist?s questions…,

    … at the root of this Global Financial Crisis (GFC) lies the moral failure of humanity. Through this moral failure, the world is allowed to get carried away and believe in what it wants to believe.

    Rules and regulations can only work up to a certain extent because beyond that, it is impossible to legislate morality.

  4. No matter how tight and comprehensive rules and regulations are, there will always be loopholes and gaps to allow circumvention. For example, as Satyajit Das revealed in his book Traders, Guns & Money, derivatives routinely make a mockery out of laws. It has come to a point that poking holes at the legal system via derivatives has become a sport!

As we quoted Jimmy Rogers in Jimmy Rogers: ?Abolish the Fed?,

More regulations? You want Alan Greenspan and Ben Bernanke? These are the guys who got us into this situation. They are supposed to be regulating the banking system for the past 50 years. These are the guys who let it all happen. I don?t want more regulations. Let the market regulate it. If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.

If the Federal Reserve did not bail out LTCM in 1998 and let it go bankrupt instead, it would have sent a very strong signal to the market back then.

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One day, the GFC will end. But this generation will leave a legacy of corruption and inefficiency for the next if today’s governments continue to intervene in such an unprecedented scale.

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  • Pete

    LTCM: (from wikipedia)

    Long-Term Capital Management (LTCM) was a U.S. hedge fund which used trading strategies such as fixed income arbitrage, statistical arbitrage, and pairs trading, combined with high leverage. It failed spectacularly in the late 1990s, leading to a massive bailout by other major banks and investment houses, which was supervised by the Federal Reserve.

    Good article Ed

    You mention that the government actions will affect the next government and so on…what I am continually wondering is how significant the impact of the government interventions will be. For instance, is it really possible that the government could bail out the entire economy? Sure we’d rack up a lot of debt, or add to our monetary base (printing) but perhaps we would not see the effects of that for a long time?

    I guess if the government persists in giving us a ‘soft landing’ then I would expect our recession/recovery to look not like a V shape, but much rather like a very stretched V shape, many times wider than its height.

    The reason I say that is because all of the government interventions would need to be paid for, which would hamper our recovery significantly in my mind.

    So as you say Ed, its looking a bit like the companies of today are being saved at the expense of the next generation.

  • Pete

    LTCM: (from wikipedia)

    Long-Term Capital Management (LTCM) was a U.S. hedge fund which used trading strategies such as fixed income arbitrage, statistical arbitrage, and pairs trading, combined with high leverage. It failed spectacularly in the late 1990s, leading to a massive bailout by other major banks and investment houses, which was supervised by the Federal Reserve.

    Good article Ed

    You mention that the government actions will affect the next government and so on…what I am continually wondering is how significant the impact of the government interventions will be. For instance, is it really possible that the government could bail out the entire economy? Sure we’d rack up a lot of debt, or add to our monetary base (printing) but perhaps we would not see the effects of that for a long time?

    I guess if the government persists in giving us a ‘soft landing’ then I would expect our recession/recovery to look not like a V shape, but much rather like a very stretched V shape, many times wider than its height.

    The reason I say that is because all of the government interventions would need to be paid for, which would hamper our recovery significantly in my mind.

    So as you say Ed, its looking a bit like the companies of today are being saved at the expense of the next generation.

  • Pete

    Sorry I derailed my train of thought before – what I was also getting at was that I have been wondering what the impact on government interventions will be for investing.

    I doubt anyone other than the beureaucrats can really know, but it does make me wonder how good certain advice is.

    For instance, if the government absolutely devotes itself to propping up the real-estate sector, then perhaps it is a good idea to buy. What if the government does the same for the big four banks, etc.

    What if one was to invest in Blue Chips, with the idea that they are ‘too big to fail’ (gov. intervention likely) and are therefore very safe?

    That said, it seems to me that individual companies that are bailed out will not prosper. The very notion that they require a bailout means they are trading close to or in the red. Even with a neat government loan, they will still need to fight their way out of their own mess. The extra gov. debt, the poor business modelling and the poor markets would not seem like a good combination for strong earnings.
    So then, low earnings and no sniff of dividends would surely smash them in the sharemarket.
    (lets not speculate on takeovers…if anyone could even afford them).

    That was a bit rambly, just like my thought patterns

  • Pete

    Sorry I derailed my train of thought before – what I was also getting at was that I have been wondering what the impact on government interventions will be for investing.

    I doubt anyone other than the beureaucrats can really know, but it does make me wonder how good certain advice is.

    For instance, if the government absolutely devotes itself to propping up the real-estate sector, then perhaps it is a good idea to buy. What if the government does the same for the big four banks, etc.

    What if one was to invest in Blue Chips, with the idea that they are ‘too big to fail’ (gov. intervention likely) and are therefore very safe?

    That said, it seems to me that individual companies that are bailed out will not prosper. The very notion that they require a bailout means they are trading close to or in the red. Even with a neat government loan, they will still need to fight their way out of their own mess. The extra gov. debt, the poor business modelling and the poor markets would not seem like a good combination for strong earnings.
    So then, low earnings and no sniff of dividends would surely smash them in the sharemarket.
    (lets not speculate on takeovers…if anyone could even afford them).

    That was a bit rambly, just like my thought patterns

  • http://contrarianinvestorsjournal.com Contrarian Investors? Journal

    Hi Pete!

    Is it really possible that the government could bail out the entire economy? Sure we?d rack up a lot of debt, or add to our monetary base (printing) but perhaps we would not see the effects of that for a long time?

    It is possible, but not necessarily with money. If the government is to ‘bail out’ the entire economy, it will come in the form of a new political ideology whereby authoritarianism goes on the ascent. North Korea is an extreme example.

    Sorry I derailed my train of thought before – what I was also getting at was that I have been wondering what the impact on government interventions will be for investing.

    A very good point, Pete. We will talk more about that in the next article.

  • http://contrarianinvestorsjournal.com Contrarian Investors’ Journal Editor

    Hi Pete!

    Is it really possible that the government could bail out the entire economy? Sure we?d rack up a lot of debt, or add to our monetary base (printing) but perhaps we would not see the effects of that for a long time?

    It is possible, but not necessarily with money. If the government is to ‘bail out’ the entire economy, it will come in the form of a new political ideology whereby authoritarianism goes on the ascent. North Korea is an extreme example.

    Sorry I derailed my train of thought before – what I was also getting at was that I have been wondering what the impact on government interventions will be for investing.

    A very good point, Pete. We will talk more about that in the next article.

  • Pete

    Cheers Ed :D

  • Pete

    Cheers Ed :D

  • HiredGoon

    Great article, and a perspective conspicuously absent from the mainstream.

  • HiredGoon

    Great article, and a perspective conspicuously absent from the mainstream.

  • Guest

    Allen Greenspan was actually very against most regulations tho he did make quite a few. He knew the best way to propel an economy forward was for government to not intervene in regulation because the market has a natural regulating system of its own. Such a regulating system is called investors.