Tuesday, February 10, 2009

Bailouts Promote Complacency and Underperformance

Watching President Obama on television last night, I spent some time thinking about the big picture, and the situation our country is in. The president's tone has clearly shifted from hopeful and optimistic to someone resorting to typical Washington politics. He's resorting to fear to get this recovery package passed because the bill has faced much more resistance then expected. His administration believed the election gave them a mandate to spend however they chose, and to make up for the last eight years. The quote from his Chief of Staff Rahm Emanuel said it all. "Never let a serious crisis go to waste. What I mean by that is it's an opportunity to do things you couldn't do before."

So here we sit, with a massive economic stimulus bill on the verge of being passed. Once that is finished, we're almost certain to see another bailout bill to give more credit to banks. This will be TARP II, or something like it. I read a lot of commentary at the Ludwig von Mises Institute, where they talk about Austrain Economics, or basically free market capitalism in its purest sense. They talk a lot about the necessity of letting failing companies fail, and how destructive bailouts can be.

There's a great piece out there today called The Importance of Failure by Tyler A. Watts. I've highlighted a couple of meaningful quotes here:

Bailouts are designed to insulate people from the effects of bad decisions. When market prices change dramatically, exposing yesterday's poor investment choices, bailouts come "to the rescue," promising those left holding the bag that they won't have to endure the full cost of their errors.

But we should realize, as the fine print always says, that prices are subject to change. Change is a defining feature of markets. Entrepreneurs make money by casting about for "wrong" prices and making bets on what direction particular prices will move in the future. Successful entrepreneurs, who correctly anticipate price changes, are rewarded with profits. Erroneous entrepreneurs, who do a poor job of estimating price movements, are penalized with losses. This is the essence of the market process.

Bailouts, then, attempt to erase the effects of losses, or economic failure. But such efforts inevitably undermine the loss aspect of "profit and loss." Profit and loss go together — like up and down, left and right, good and bad. If we try to do away with losses, we'll wind up diluting the meaning of profits. After all, why strive for profits if Uncle Sam will cover your losses with a bailout? Why bust your butt to compete and succeed if you can just clamor for a handout instead? Bailouts destroy the profit motive — and all the benefits of a competitive economy.

There's a great irony in bailouts, too. The only reason we can afford to even talk about bailouts is because of the accumulated wealth brought about by centuries of capitalism.

My favorite quote is "If we try to do away with losses, we'll wind up diluting the meaning of profits." This is the essence of this line of thought. Bailouts cause people to become complacent. People won't strive to be their best when they know they have a safety net under them. In fact, people (and companies) will get lazy and take greater risks because the potential for losses is weakened or even gone. Never underestimate the power of self-motivation by personal need. The guy who needs it the most will always find a way to get the job done, and that has been proven. If we disrupt this balance amongst markets, work ethic and productivity will erode over time. The biggest reason for American success is its people. Their attitude, work ethic, and optimism. When you destroy that, you're asking for lasting negative effects.

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