The Perpetual Bailout Machine

Failure is a part of U.S. business culture. That is why Americans feel extremely comfortable buying tickets from bankrupt airlines, electronics from bankrupt retailers, and apartments from bankrupt builders. To paraphrase a popular bumper sticker: bankruptcy happens. Bankruptcy does not have to be the end for any business. Instead bankruptcy, under Chapter 11, offers court-supervised protection from creditors so that a business can reorganize itself into a new successful form. The larger and more complicated a company is, however, the more preparation it must do before it can enter Chapter 11. In fact the executives of businesses facing tough economic times have a fiduciary duty to their shareholders and creditors to develop a bankruptcy plan. Only the most irresponsible executives would shirk this duty, and only the most conniving would do so knowingly as part of an effort to blackmail the American taxpayer. Enter General Motors CEO Rick Wagoner.

Testifying before Congress yesterday, Wagoner admitted that GM has “put virtually all effort into avoiding” bankruptcy and has not worked out a detailed contingency plan. By contrast, Chrysler CEO Robert Nardelli said his company has “looked at all aspects” of a potential bankruptcy filing and has “gone through advisers to help us think this through.” The Wall Street Journal reports:

Because of its refusal to make plans for a bankruptcy, GM is “courting a Lehman-like situation,” said a person familiar with the matter. Lehman Brothers, the storied investment bank, collapsed into a court-protected reorganization unprepared to remain in business. “They are on the train tracks and won’t get off them,” the person said.

In other words, by willfully failing to plan, Wagoner is trying to maximize the pain a GM bankruptcy would cause so that Congress is forced to act. Giving in to Wagoner’s cynical game of chicken would be a disaster for the economy. If the possibility of a federal bailout did not exist, Wagoner would have no choice but to spend the last months acting responsibly and preparing for GM’s bankruptcy. Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. By granting GM its desired bailout, the federal government would only encourage other CEOs to act as irresponsibly as Wagoner.

When examining most patents, the United States Patent and Trademark Office requires only a written description of an invention and its uses. But any applicant claiming to have invented a perpetual motion machine must also submit a working model for examination. If Congress, or the Obama Administration, grants GM its bailout, they will have created a perpetual bailout machine, one that prompts every troubled industry in the country to abandon its fiduciary duty to plan for the worst and, instead, come to Washington demanding a handout.

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