Published: January 02, 2009 09:43 pm         

Government takes step back in 2008

Economically speaking, 2008 was a dismal year. The economy entered a year-long recession during which it has shed more than two million jobs. The price of oil went on a roller coaster ride, soaring by 45 percent to $145/barrel in the first seven and a half months of the year before plummeting by more than $100 in the final four and a half months. The stock market nosedived, with the S&P 500 losing 38 percent of its value. And iconic corporations like General Motors, Chrysler, AIG and Citigroup teetered on the verge of bankruptcy. Yet the most disappointing economic event of 2008 was that it was the year that socialism once again became fashionable.

Throughout the 20th century the U.S. government criticized the governments of other nations for meddling too much in economic affairs. We argued, correctly, that government-owned planned economies make the people in those economies poorer. Yet, since October the federal government has purchased $177 billion of preferred stock in financial institutions across the nation — including one here in Oklahoma ($70 million of Southwest Bancorp in Stillwater).

This number will likely rise to $250 billion early next year as the federal government continues to process applications from additional financial institutions. Furthermore, the $250 billion figure does not include the ownership stake the government has taken in Fannie Mae, Freddie Mac and AIG during the past six months. Apparently, the U.S. government has decided that it is OK for government to own private corporations after all.

This is a big mistake.

While these are extraordinary times that call for extraordinary actions, even extraordinary times do not justify bad public policy. Frankly, government ownership of corporations is very bad policy.

History shows us that government just is not effective at running businesses, or even choosing which businesses to support. Like a gambler that habitually bets on the long shot, governmental aid tends to go to the weakest and least efficient companies.

For example, during the past few weeks the federal government has offered to loan General Motors and Chrysler — the two most troubled U.S. automakers — billions of dollars in order to stave off bankruptcy. Then this last week the Bush Administration provided an additional $5 billion of capital to GMAC, the financing company jointly owned by General Motors and Cerberus (the company that owns Chrysler). General Motors quickly took advantage of this new funding and began offering 0 percent interest car loans for new car buyers. Essentially, the U.S. government is now helping GM sell cars. However, the government is not offering this same assistance to other automobile manufacturers. In other words, the federal government is now betting on the long shots.

This does not mean, though, that government has no role to play in this crisis. Instead of following an example of poor public policy, the federal government should look to its most successful program for inspiration.

Back in 1934, in response to another financial crisis, the federal government created the Federal Deposit Insurance Corporation, better known by its acronym FDIC, in order to protect depositors in case of a bank failure. Prior to the FDIC, a bank failure could mean that all depositors in the failing institution lost all of their deposits. Not surprisingly, even the slightest hint of a failure could lead to a run on the bank as many depositors would try to withdraw their funds simultaneously. These bank runs increased anxiety and concern over all banks’ health, leading to widespread financial panic — that would threaten even healthy banks.

With FDIC insurance though, depositors know that their deposits are safe even if the bank fails. Thus, healthy banks are unaffected by the failure of an unhealthy bank. It is because of deposit insurance that there is no widespread financial panic among bank consumers today.

Notice that with the FDIC the government does not try to keep failing banks alive, the government just mitigates the collateral damage. We need a similar approach with this crisis. Instead of focusing on saving corporations who have made too many bad decisions, the government should let them fail and focus on limiting the collateral damage. For example, instead of trying to save General Motors (a company that has been poorly managed for decades), the government should focus on limiting the impact on suppliers and healthy competitors. Instead of trying to save Citigroup (another company that has made horrendous mistakes), the government should focus on ensuring that commerce continues unaffected.

In the 20th century the grand economic debate centered on the issue of private ownership vs. public ownership of business, free markets vs. socialism. Like most, I thought the side favoring private ownership and free markets won. Unfortunately in 2008, socialism made a comeback.

MICKEY HEPNER is an associate professor of economics at the University of Central Oklahoma.

     

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