Sunday, March 8, 2009

Too Big NOT to Fail

One of the litanies we've been hearing the last several months about the financial collapse is that some companies are "too big to fail" -- firms like Goldman Sachs, AIG, Citigroup, GM, Chrysler, and the biggest of all, of course, Fannie Mae and Freddie Mac. And then there's the firms that got rolled into other firms, like Bear Stearns (into JP Morgan Chase), Wamu (also taken over by Chase), Countrywide (taken over by B of A), Indymac (taken over by the Feds), etc. And I'm sure I'm missiing a few at this point.
Why are they all "too big to fail"?
As John Allison, CEO of one of the few healthy large banks in the country (BB&T), remarked in Washington, D.C. a few weeks ago (see, the demise of Wamu and Countrywide were good things for the world.
If Citigroup failed, I would say the same -- it's shares have fallen from $55 to $1, but it remains a bottomless pit for government largesse.
AIG -- not much better. Allison remarked in his talk that the subordinate companies under AIG (my paraphrase, from memory) would carry on just fine.
GM/Chrysler? They would get out from under onerous union contracts that have made them uncompetitive for decades. But the government (and their own CEOs) still wants to pump up to $130 billion into the life support machine, with no prospect for survival.
Goldman Sachs? They were one of the biggest offenders in the Mortgage Backed Securities business that led to this crisis, creating many of the 5 star derivatives comprised of too many 5 star bad loans.
Why were they saved? (Aside from Hank Paulson, that is, the clever chap who made $500 million dollars by pushing Goldman into MBS's, earning a fortune in stock options for it, and then pulling strings to get the Treasury Secretary job so he could sell his stock tax-free -- as required by U.S. law to avoid a "conflict of interest"! -- before the MBS roof came crashing down.)
I'm not a finance type, just an observer, but I'll offer an insight that I think has real validity, but which I haven't heard discussed elsewhere.
Who owns the stock in these companies, and the debt owed by these companies?
To understand the "too big to fail" concept, you have to think about this, because the principle to understanding the "bailout" is: follow the money.
Large-cap companies are largely owned by wealthy individuals and large investment funds. Both exert a lot of influence -- they lobby, donate to political campaigns, and hobknob with power-brokers. Large sums of money pretty much have to mostly be put to work in large companies (directly by stock purchase, or indirectly via a mutual or hedge fund) because the sums are too great to put into smaller companies.
Now, here we are: the economy is collapsing because government policies induced a lot of large companies to pursue a lot of foolish (and sometimes corrupt) business strategies, like issuing sub-prime home loans to millions of unqualified borrowers, or entering the Mortgage Backed Securities business of derivatives on those loans. Many very wealthy people were content to let their financial advisors invest in those businesses. (The best example of that psychology is the people who invested in Bernie Madoff, directly or indirectly.)
Now, chickens have come home to roost, but this time as a giant flock of vultures, and these people see that their investments -- Goldman, AIG, GM, etc -- are all facing imminent failure and bankruptcy.
If you're one of these people, and you paid your political dues for years and years, what would you do?
Let me take GM as an example: virtually everyone will tell you that going into bankruptcy would be a good thing for GM -- they could void their union contracts, reorganize, modernize plants, cut excess labor, and be enormously more competitive. Yet the unions don't want this (not surprisingly), Obama and the Democrats don't want this (not surprisingly), and even management of GM doesn't want this (all those stock options become worthless, you see).
But would that be enough to get a government bailout? Maybe, maybe not.
So a new argument is given: "too big to fail" -- a non-argument, really. The proponents of this theory say the failure of such large businesses would cause massive supply chain disruptions (manufacturing, dealerships, parts stores), loss of jobs, yadayada, along with other rationalizations.
Yet you won't hear many people say there aren't alternatives in other automakers -- Ford, Japanese cars, Korea, etc. Knowledgable and honest experts would tell you that the manufacturing capacity of GM could quickly be replaced.
And let's face it, all the people running those companies wouldn't die -- they'd still be around. If capital was available, the best people from GM and Chrysler could finance new automobile start-ups. Within the huge bureaucracies of GM or Chrysler, they represent terribly misallocated human capital unable to achieve their full potential. GM's failure would be a good thing for the world, and the country.
So why the continuing push to save GM?
Putting aside the loss of union votes to Democrats (a huge reason the Dems support the bailout, of course), the simple fact is that bankruptcy of GM would leave shareholders and debtholders out in the cold: Shareholders would lose ALL the value of their stocks. Every large shareholder (private or hedge fund) would see billions and billions in losses. Likewise, debtholders -- those who lent GM money would get almost nothing.
Multiply this analysis times AIG, Citigroup, Goldman, ad infinitum.
If you were one of those who could be left out in the cold, and if you were driven by desperation and not too constrained by moral principles or common sense and had the political influence at your disposal (paid for in large campaign contributions over the years), what would you do?
You would scream bloody murder to keep those companies you'd invested in out of bankruptcy. You would demand the injection of huge sums of government money, regardless of the cost to the rest of the country, because you imagine it's the only way to preserve your investment, and probably your entire net worth.
For this we are being sold down the road, and for this our economy, our businesses, our livelihoods, our futures, our rights, our system of government and our way of life are being destroyed.
This is what government interference in the economy begets: it creates the problem, and then, by means of those who are part of the "Aristocracy of Pull" (as Ayn Rand put it in Atlas Shrugged), government sustains and expands the problem until it becomes life-threatening.
Consider this excert from Atlas Shrugged, when wealthy playboy Francisco d'Anconia answers Jim Taggart, who best exemplifies the kind of man I'm taking about, the kind that runs to the government to make him money and then pull him out of trouble when things go wrong. After crashing Taggart's wedding, d'Anconia is confronted over the losses Taggart has incurred as a result of Francisco's mismanagement of his family business:

"You didn't think I'd want to miss your wedding, James--when you're my childhood friend and best stockholder?"

"What?" gasped Taggart, and regretted it: the sound was a confession of panic.

Francisco did not seem to take note of it; he said, his voice gaily innocent, "Oh, but of course I know it. I know the stooge behind the stooge behind every name on the list of the stockholders of d'Anconia Copper. It's surprising how many men by the name of Smith and Gomez are rich enough to own big chunks of the richest corporation in the world--so you can't blame me if I was curious to learn what distinguished persons I actually have among my minority stockholders. I seem to be popular with an astonishing collection of public figures from all over the world--from People's States where you wouldn't think there's any money left at all."

From that you can read all the other implications and comparisons to my argument here.
I've focused primarily on the shareholders and debtholders here, not to diminish other influences -- unions, quest for political power, etc -- but because I think for most companies as a whole, the shareholders are the biggest factor for the "too big to fail" phenomena.
And remember -- all the people in government, including Congressmen and Senators, had to put their money somewhere, too (more often than you might realize, I'm sure, if you could dig deep enough): in the stocks and mutual funds and hedge funds that are going broke.
Now throw in the investment analysts (the Jim Cramer's, for instance), the media pundits, and everyone else who counted on riding on someone else's brains for their investments. You can see there is a tremendous conflict of interest whenever you hear calls from across the spectrum to save companies that are "too big to fail".
What they mean, is, they don't want to fail, and they want everyone else to support their imprudent investment decisions. They want us to keep them in business -- and the price they want us to pay for that privilege is our lives, our livelihoods and our liberty.
There is *only* one solution to prevent this happening again (if we get that chance): just as there must be a separation of Church and State (for the obvious reason that where the State controls the Church, they can control what you can believe or think), so there must be a separation of State and Economics.
We desperately need a constitutional amendment to to divorce the State from any form of economic activity, whether by printing money, taxation of business activity, regulating business operations, or government ownership of *any* activity outside it's essential functions of protecting individual rights -- the courts, police and national defense.
It is primarily through controls of economic activity that politicians acquire their power -- the power that attracts lobbyists and influence-peddlers and campaign donations and kickbacks. The kind of things influencing this crisis in a desperate gambit by the unscrupulous to retain their wealth at the expense of everyone else.
Some people will argue that regulation, taxation and limited government ownership in industry is essential -- but don't they see, this is the same argument as "too big to fail"; if you say this, your arguments will ultimately lead to your own destruction. Change the wording a little bit, dress it up with a sequined gown and lipstick, and the argument "too big to fail" is still a pig. Leaving government in control of the economy is bailing out the pig.
What we're witnessing now is a chorus line of 535 pigs plus 1 in the White House, on stage in Washington, doing a high-kicking dance in embarrassingly tight-fitting garments to the forced amusement of the rest of us, who must endure it without even the pleasure of making cat-calls.
I say, pull the curtain on this pathetic imitation of the Follies Bergere. It's too big not to fail.