Why Bailouts Are The Solution For Companies That Are Too Big To Fail

Snapshot

• Ideal regulators may reduce the necessity of a bailout; however, they may still be required during times of extreme duress.

  In such situations, we must bite the silver bullet; go ahead with them in the larger interest of people and the global economy.

India’s telecom sector has received some relief from the government; however, many are pointing out how it is not enough. Indeed, it is not enough as the sector has been a cash-cow for successive governments, and therefore, there is a fiduciary duty to ensure its stability.

Whether there will be more measures to help these companies or not is a decision that the appropriate department must take. However, there is no denying that more needs to be done for the telecom sector.

But this article is not just limited to the telecom sector. As a free-market libertarian, I am criticised by many when I want specific packages to be announced to rescue private sector enterprises. People allege that I support socialising losses at a time when profits are mostly private. Others call me a pseudo-libertarian.

Whatever term they may impose on me, it is important to argue based on facts, evidence and the larger public interest in mind.

Therefore, one must evaluate the cost of the lack of an intervention with the cost of an intervention. In the case of telecom, intervention is less costly, so it is logical to intervene.

There exists a severe misconception with regards to what means a free market as many believe them to imply no government interventions.

However, for free markets to truly remain free, government intervention is required from time to time. Such intervention must come in various forms such as removing entry and exit barriers or enforcing anti-trust legislation to avoid concentration of market power.

The question is what happens when the government fails at both? Monopolies or oligopolies.

A bailout to a private monopolist using tax-funded money makes no sense.

However, when there is consolidation of an otherwise competitive sector and there emerges stress due to regulatory developments, then the lack of a bailout can result in the sector becoming a duopoly. Such a situation is a genuine case to reconsider the level of government support.

Case in point is the North Atlantic Financial Crisis where several banks were taken over by the Fed, however, when it came to Lehman, it failed to generate adequate capital from investors and the government could not intervene or perhaps decided against intervening at that moment.

Sometimes, to not decide is also a strong decision and therefore, eventually Lehman filed for bankruptcy and it sent shockwaves across the financial system. It is precisely here that we must ask this question; was it worth it to allow Lehman to collapse? Or, perhaps would a bailout of the same be enough to prevent the global meltdown?

Unfortunately, it is difficult to evaluate such counterfactuals in the real world and this makes it difficult.

However, even in the choice of uncertainty, you pick an outcome that has the least expected costs. Therefore, many argued that the failure to rescue Lehman resulted in a significant loss of faith in the financial crisis which precipitated the global meltdown.

Should there have been a bailout, perhaps the problem may not have gone away and persisted however, despite that, it would have cost significantly less.

A lot of modern economic management is about managing expectations as expectations can often be self-fulfilling and therefore, measures such as capital injections or government intervention can help in stabilising sectors through difficult periods.

The reason behind bailouts for too big to fail companies was simple, the collapse of these mega institutions would take with them the entire global financial system and therefore, the costs of their failure was higher than the cost of a bailout.

So, does it imply we should socialise losses and privatise profits? Of course not. Any such bailout must be designed in a manner that ensures recovery of public funds once the company starts generating profits. The US bought preferred shares when it injected cheap capital into several of the US banks and therefore, the bailout money was recovered (if we adjust it for inflation then there was a small loss).

If some people argue against any bailouts, then we must strongly disagree with them. If some people argue for bailouts or tax handouts every time there is a problem, then we must strongly disagree with them too. Bailouts may be necessary at times, but they must always be the last policy intervention. However, whenever a bailout it necessary it must be adequate and swift to send a strong signal to everyone.

It is important to further recognise bailouts to often be a solution to a problem caused by regulatory failures.

Therefore, it is imperative to focus on strengthening our regulatory frameworks and making them modern to accommodate to our dynamic economy. The best regulator is not the one who controls the sector but one who grows it through prudent regulation for a sustained period.

Ideal regulators may reduce the necessity of a bailout; however, they may still be required during times of extreme duress. In such situations, we must bite the silver bullet; go ahead with them in the larger interest of people and the global economy.