On the Hook for More Bailouts | Citizens Against Government Waste

On the Hook for More Bailouts

The WasteWatcher

On July 9, 2013, the Financial Stability Oversight Council voted to categorize American International Group (AIG) and GE Capital as systemically important according to a Washington Post article on the same day.  The designations were provided for by the Dodd-Frank Wall Street Reform and Consumer Protection Act after the financial crisis of 2008.  AIG came close to a shutdown in 2008 before the government provided a bailout in excess of $180 billion.  The legislation aimed to address the perception that a lack of oversight caused these events and the financial crisis as a whole.  Increasing oversight, Dodd-Frank was intended to reduce the risk of systemic collapse.

While many may applaud further regulation of companies in the financial sector, critics such as John Allison, former Chief Executive Officer of BB&T, argue that the financial crisis was, in reality, brought on by government intervention in the market.  In his book The Financial Crisis and the Free Market Cure, Allison points out that the crisis occurred despite the financial industry being one of the most highly regulated industries in the world.  A lack of oversight is not necessarily what creates risk; what does create risk is the set of perverse incentives created by government regulation.

Designating an entity as systemically important very clearly sends a message to the company that the federal government considers it to be too big to fail.  Proclaiming a company’s success to be essential to the prosperity of the country warps risk taking incentives.  A World Bank study published in January 2013 found that bondholders of large financial institutions that expect government support due to their size do not internalize risk in the way smaller banks’ bondholders do.

Still, the insistence that oversight is the ultimate solution for preventing risky behavior has been prevalent.  Now both AIG and GE Capital have been officially declared too big to fail.  While the intention is to stem risk, it is clear that this label assures corporations that they are insured against failure by the government.  As economist Peter Leeson has said in response to the book Too Big To Fail by Gary H. Stern and Ron J. Feldman,

“If someone pays you for your accidents, you will expend less effort trying to avoid them. Insurance companies understand this perfectly well. That’s why most insurance contracts include customer deductibles and limited coverage. This seems straightforward enough. Why is it, then, that policymakers appear to have missed this important lesson?”

When the danger of going out of business is absent, these large corporations can take risks which smaller firms cannot.  This guarantee against failure is blatant corporate welfare; it protects huge corporations from bankruptcy while leaving small firms to function in the market.  It grants large corporations the ability to engage in risky behavior without consequence.  Classifying a corporation as systemically important does not protect consumers from systemic collapse, but instead shields corporations from competition and puts taxpayers on the hook for their future mistakes.

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