Government Bailouts of Corporations - Essay Example

Inserts His/her Inserts Inserts Grade (29, 06, Government Bailouts of Corporations Introduction According to economists, allowing financial institutions and international corporations to go bankrupt could have an adverse effect on the government and especially on the citizens who depend on these organizations. Companies such as AIG, General Motors, Fannie Mae and Freddie Mac should be offered Government bailouts because they provide quality products and services for their customers along with creating numerous job opportunities for the citizens of the country. According to the people in favor of the bailout plan, the economy needs rescue and helping the institutions in financial crisis will play a vital role in reviving the economy. There are however some economists who are strictly against government bailouts. According to them the government will not increase taxes or reduce government spending in other areas to pay for this bailout. What will happen is the Federal Reserve will increase the money supply to continue funding the large government deficit that will eventually result in inflation and a devaluation of the US Dollar. I will argue against government bailouts of corporations because bailouts are against the foundations of capitalism and they adversely affect the decision making process in corporations. What is Meant by Bankruptcy and Government Bail-outs? Bankruptcy is a situation where a business runs out of money because the outflow of cash becomes higher than the inflows which results in the business not able to recover its costs. This is where the government comes into action and offers bailouts so such businesses can get stable. A government bailout is a phenomenon in which the government provides loans to a company or country which faces serious financial crisis. It could be done for profit, as when an investor stabilizes a struggling company by buying its shares at fire-sale prices so it could improve socially and economically, but is unable to get an appropriate response. Under such circumstances the government bailout of a company might be seen as a necessity to prevent greater economic failures. For example, the government of the US believes that the transportation industry is the backbone of Americas economic fluency and that it maintains the country’s geopolitical power. Therefore, it is the policy of the US government to protect the biggest American companies responsible for transportation from failure and provide them subsidies and low-interest loans. These companies are recognized as "too big to fail" because their goods and services are considered by the government to be constant universal necessities that help maintain the nation’s welfare and security to a great extent (Fernholz, 23-50). Corporations and Economic crisis The economic downfall in 2007 is considered the second worst recession in American economic history. It started within the housing market and gradually expanded to other business sectors as well. To be exact, the U.S GDP failed by nearly 7% (Painter & Duggan, 63-261). American citizens were struggling for jobs because the unemployment rate reached 9.7%. Many retired people lost their money due to the failure of many investment vehicles. The performance of the stock market declined exponentially and it was as good as going bankrupt. Therefore, to avoid another Great Depression, the government and the Federal Reserve Bank got involved to stabilize the economy using various policies. These efforts definitely helped to improve and gave a glimpse of hope for households and businesses to recover from financial crisis. Many economists however believe that these policies might contain potential risks of future inflation and debts. For example, the U.S. government provided nearly $ 200 billion to take over Fannie Mae and Freddie Mac, two mortgage companies that were struggling badly. The move is counted as an expensive gamble to rescue the housing crisis. The U.S. Treasury Department has provided each company with about 100 billion dollars through the purchase of preferred stock to make sure the company does not face bankruptcy. Mortgage lenders were underwriting the value of real estate accounting for 50% of this market (Berle & Means, 25-119). Since 2006, two giants have lost $ 14 billion and this would keep increasing until the housing market recovery. This is the reason the U.S. government holds nearly 80% stake in each company and keeps buying the debts of the two firms. The Federal Reserve gave $85 billion to one of the biggest insurance companies called AIG. It has been reported that the worlds largest loans were provided to save AIG from the risk of melting down. Therefore, it is not a surprise to see that the U.S. government holds a 79.9% stake in AIG and even has the right to replace the leadership of the company (McChesney, 333). FED believed that AIG was too big to fail, if companies of such caliber go under, it can drag others down with them. AIG, the insurance giant, offers insurance cover for major organizations and individuals in the U.S. If the company went bankrupt, it would be a huge loss for the economy of the country as millions of covers and policies go unpaid. Why shouldn’t government bailout corporations? It is true that we must not blame bankers and other corporate heads for the economic meltdown in 2008, but it looks as if the bankers want to take advantage of profits when the economy is stable and pass the burden to taxpayers when it is facing serious crisis. Government assistant is also significant when there is absolute instability in the financial system such that the status of the economy is completely at risk, however, these corporations should be asked to present accountability for the actions, and not just hand them a bailout every time we have a financial downfall. If they receive a bailout, there should be conditions that no one will be given a bonus with taxpayer money. Executives should only receive bonuses if a company is profitable, and with their own funds, not with the money of the taxpayers. The people of America face the same financial crisis as corporations do. They, unfortunately, watch their investments wither away to nothing and have to suffer higher costs of living. When families face financial troubles they buckle up, work hard, and reduce their spending instead of asking someone or the government for bailout. It has been witnessed that little has been done to help people stay in their homes. On the other hand, bailouts have been provided for the banking sector to help them out of their financial crisis. With unemployment being above 10%, and foreclosures on the rise, it was quite obvious that the banking sector should have been provided assistance at the last (Hilsenrath, 212). Therefore, while the government is busy bailing out these firms, people on Main Street are losing their homes, jobs, and everything they have strived hard for. How bailouts are against the spirit of Capitalism Bailouts show disrespect for the capitalist philosophy of the importance of losses for preserving capitalism. As far as economic history is concerned, the need for banking system bailouts spares no class of nation. Furthermore, it has been shown that from 1974 to 2009 there are only two years, 1975–1976, in which a banking system bailout did not take place anywhere in the world. According to economists, average banking system bailouts have cost nations 13% of their gross domestic product. While there are some bailouts in the US that have cost as little as 0.1% of GDP in the years 1974 and 1984, others bailouts in Turkey have cost a staggering 61.9% of GDP in the year 2000. Furthermore, it takes nearly 4 years for an economy to regain its footing after a bailout. This shows that the costs of these bailouts are large and the effects long-lasting. As far as United States is concerned, its first two bailouts were the same size on a percent-of-GDP basis. But the second bailout that happened ten years later was larger by more than $3 billion. Therefore, GDP growth in the United States from 1974–1984 slightly exceeded the growth in the size of the bailout. Hence a capitalist who wants to preserve the sanctity of losses for the proper functioning of capitalism will ask for bailouts minimization by highlighting that bailouts seem to result in future bailouts of even greater size. Government bailouts and decision making in large firms There are certain issues in the bailout context that are relevant to government ethics. These issues include the role of political bias in government decisions, movement of executives between government and the private institutions, sloppy rules for federal contractors, and other issues. However, bailouts are unique in many ways: the huge amount of government expenditure required; the complex financial relationships between the companies that receive bailouts with other companies; the individuals who benefit from the bailouts in the finance industry; and the lack of procedural rules for the employees of the government who receive bailouts as compared with detailed regulations for particular companies. This kind of attitude from the government creates an adverse effect on the economy of the nation. Furthermore, it can cause federal bailout money to be spent inappropriately. Lack of public confidence in the decisions made by the government regarding bailouts, and also shakes the confidence of an investor in the financial markets. However, not all bailouts are of same nature. There are certain bailouts such as bailouts of depository organizations insured by the federal government according to the rules. Federal institutions such as the FDIC administer these bailouts that are mostly staffed by the career officials (Richard, 20). Therefore, there are fewer chances that biased or inappropriate decisions are made regarding bailouts. It has been witnessed that some bailouts are meaningless because they involve companies that ordinarily would be allowed to fail. Policy makers believe that these companies are too big to fail and if they are dissolved, it will be a huge loss for the economy. These government decisions are unpredictable. There are no prearranged legal rules to carry out these bailouts. Political appointees make most of these decisions themselves, and sometimes the decisions are found illogical (e.g., Bear Stearns and AIG are provided government bailouts, but Lehman Brothers were refused). Such decisions could hurt the economy badly, and it may also cause capital markets to react adversely. When the public’s money is invested in private institutions, it is their right to get an ownership stake in debt, equity, or both, however, the public has fewer rights to control the conduct of government employees who are managing this trillion dollar enterprise. The shareholders who do not accept government bailouts do not have much control over managers either, but even these shareholders probably have more options than the public if they are not satisfied with the management of government bailout funds. The taxpayers are obliged to wait for the next election to act upon their views of the government’s bailout management. In this respect, government until now has been viewed principally as one of the biggest problems of the private sector. Status of companies that have been bailed out The companies that have been bailed out by the government are listed below: Lockheed Aircraft Corporation and Chrysler In 1971 Lockheed Aircraft Corporation was facing severe financial crisis during a production run on a new line of jets. Lockheed reported that without a government bailout, the company would have to fire nearly 60,000 employees, and companies that were associated with them would also suffer badly (Pozen, 10). The government bailed out Lockheed by providing 250 million dollars which allowed the company to come out of this crisis. Nevertheless, they finally stopped the production of commercial jets in the late 1980s. In 1980, Chrysler was in a similar situation as Lockheed, and Lee Iacocca lobbied for 1.5 billion dollars in bailout money to avoid bankruptcy. The former President of the US, Jimmy Carter, authorized the loan in the same year and it was paid off by Chrysler in 1983. Savings and Loan Banks The savings and loan banks faced a meltdown in the 1980s, and it was estimated to cost public owners nearly 124 billion dollars. The crisis actually commenced in the 70s when they first started to struggle financially. Savings and loan banks mainly provided mortgages, but because these institutions were meant to offer low interest rates by law, it made it hard for them to compete, and customers who were associated with them moved their money to other institutions. When the government deregulated the savings and loan industry and discarded the ceiling on interest rates, institutions began making inappropriate investments that resulted in a sudden collapse. Therefore, to rescue the troubled industry Congress declared the Financial Institutions Reform which was one of the most expensive bailouts in US economic history. Housing market The housing market began to face financial crisis in 2001 when we experienced the terrorist attacks of September 11th. By 2008, the housing crisis was considered one of the biggest problems of the economy. To support the struggling economy, the Federal Reserve lowered interest rates substantially. This allowed the mortgage companies to take advantage of the situation and they started offering very low introductory rates, variable interest rate mortgages to the customers that need mortgage, including subprime customers who are facing problems paying mortgage payments. When the many adjustable-rate mortgages began to increase in early 2007, many homeowners failed to pay their mortgage payments and they lost their homes. Housing prices began to fall exponentially and the economy was affected very badly. Moreover, unemployment began to increase, the stock market began to fall, and the country went into a serious downturn. To avoid the mortgage giants going bankrupt and the economy thrashing, Congress passed a $300 billion bank bailout housing bill in July, 2008, that provided immediate funds for both lenders and borrowers (Wallsten, 119). Arguments given in favor of Government bailouts The government bailouts can also be beneficial for the economy in many ways. Below are some of its advantages: Without an appropriate lending system, recovery cannot commence The Troubled Asset Relief Program (TARP) held several provisions to improve the financial downfall. It may even appreciate the more comprehensive and intelligently designed plan of President Obama and his economic team to start working. While lending was not recovered, the recapitalization of the banks has helped avert any further bank failures. These failures require the involvement of government to settle an expensive and inefficient process at best (Robert, 111). Restrictions on FDIC insurance were inadequate It was believed that the increase in FDIC insurance will save average Americans savings in the instance of large bank failures. FDIC insurance and Federal Credit Union Insurance were therefore increased from $100,000 to $250,000 on a temporary basis (Wallsten, 220). There were two benefits in this case; individuals were satisfied that their funds are safe and secure in a bank, and the banks have the cash reserves to lend the money back into the economy. Moreover, it also prevents the kind of run on banks that encouraged the financial crisis of 1929. Alternative Minimum Tax Patch (AMT Patch) There were unrelated tax requirements that can create an impact on middle class people in the TARP which may turn out to be one of the most helpful aspects of this program. The AMT Patch was one of the tax riders attached to the bill. This will help pull the money back into people’s pockets by keeping all 2007 filers who were exempted from the tax. Federal Aid to the States The state governments are facing a serious dilemma because of the lower tax revenues. Therefore, federal aid is to provide moral support to the state and local educational systems and public safety systems. Otherwise, the states would have to drastically reduce their spending, resulting in higher unemployment and even worse economic outcomes. Automobile Industry provide Employment Opportunities Although many companies have been victims because of their corporate greed, this is a significant move to avert an economic implosion of the mid-west. But on the condition that these companies use the money to achieve what they should have achieved with their record profits in previous decades. A revised policy to factory infrastructure allows changeover of production models to 15 minutes. With this revision, they have once again a great chance to bounce back in the global economy. The bridging loans and business plan may help prevent the unemployment in the steel and plastics industries which will benefit a lot of citizens in terms of job opportunities. Education Funding To support the education sector of the country huge amount of funds were raised that would benefit the K-12 education (Schneiderman, 22-50). To stay competitive in the fast moving economic world, it is essential to continue to support both primary and secondary education. In the information economy, transforming higher education back into an elite privilege would be a great risk for the economic future of the nation. An upgrade in the Energy Infrastructure This portion of the proposed bailout helps people survive peacefully in their homes. Saving 5% of the electricity on our power grid would be one of the biggest achievements to maintain the energy independence. Therefore it is true that the TARP or any subsequent bailout will not keep the average American from feeling the pain of this crisis, but it may indeed buy the time needed for our shared economic future to turn things around and bring them back to normal. Conclusion The much-debated issue mostly comes down to a conclusion that different sides cannot agree on the best steps to be taken. The conflict in the views will continue to encourage the problems being faced by companies while no solutions are offered. The bailout of firms has both negative and positive effects on the economy of the country. If well utilized, the plan could stable the economy by preventing the major companies from melting down, increase employment and ensure constant government revenue. On the other hand, inappropriate use of funds given by the government may lead to loss of taxpayers’ funds if the loans are not paid off as per schedule. Works Cited Page Berle, A. & Means, G. The Modern Corporations and Private Property. London: Transaction Publisher, 1932. Print Painter, R. & Duggan, J. Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation. SMU Law Review, 1996. Print McChesney, F. Money for nothing: Politicians, rent Extraction and Political Extortion. London: Harvard University Press, 1997. Print Fernholz, T. The Myth of too Big to Fail: When it Comes to Banking, size isnt the only Thing that Matters. 2009. Print Hilsenrath, J. Fed Fires $600 Billion Stimulus Shot. The Wall Street Journal, 4th November 2010. Print. Pozen, P. Too Big to Save? How to fix the U.S.Financial System. N.J. Hoboken, 2010. Print Richard, P. Getting the Government America Deserves: How Ethics can make a Difference. Oxford: Oxford University Press, 2009. Print. Robert, J. The Bailout Isnt a Morality Play: Inept bankers may not deserve help, but thats not the point. Newsweek, 6th Feburary2009. Print. Schneiderman, R. Big Three bankruptcy: For and against. New York Times, 19th November 2008. Print Wallsten, P. Fresh Attack on Fed Move. The Wall Street Journal,15th November 2010. Print. Read More