The Magazine

The Bailout State

Where it came from--and how to fight it.

Jun 15, 2009, Vol. 14, No. 37 • By MATTHEW CONTINETTI
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It's not every day that you get to witness the birth of a new social system. But General Motors' June 1 bankruptcy, and the company's likely reorganization under the ownership of the U.S. Treasury, does suggest the arrival of a novel relationship--at least for the United States--between the citizen and his government. We've all encountered the national security state, where individuals give up a degree of civil liberty in exchange for protection from internal and external threats. And we live in a welfare state, where the government imposes obligations on certain individuals, in the form of taxes and duties, in order to secure basic social benefits for the entire populace. But the national security and welfare states are oh-so twentieth-century. This is a new day. This is the dawn of the bailout state.

In the bailout state, the federal government takes over failed private entities in order to maintain overall economic stability. Sometimes the companies already had ties to government, such as Fannie Mae and Freddie Mac, the Government Sponsored Enterprises (GSEs) that the Treasury seized--sorry, "took into conservatorship"--last summer. Sometimes the bailout state's beneficiaries are businesses like AIG, Citigroup, Bank of America, and the other financial institutions wedded to government through the Troubled Asset Relief Program (or TARP). Other times, the beneficiaries are unions: the United Auto Workers (UAW) whose members' jobs at Chrysler and the "new GM" will survive thanks to government largesse.

The wards of the bailout state have more in common than government support. After all, the government has supported the railroad, agriculture, and steel industries for a long time. But not through direct bailouts. No, the salient feature of the bailout state is government ownership and control.

At first the bailouts were meant to pick up the pieces that the financial crisis left in its wake. The current recession, the worst in a generation, began in the residential real estate market, spread to the banks' balance sheets, and eventually caused a collapse in short-term business lending and consumer demand. Government intervention in the GSEs was meant to stave off a total mortgage meltdown. The TARP's original purpose was to buy troubled assets from the banks and thereby shield them from insolvency. Without banks, there's no credit. Without credit, there's no economy.

Somewhere along the line, however, the game changed. GM and Chrysler's problems have little to do with the financial crisis. The U.S. car industry's woes stem from its paleolithic corporate culture, the burdensome legacy costs of generous pensions and health care for UAW retirees, a persistent failure to anticipate consumer preferences, and onerous federal regulations. The great recession landed the killer blow. When consumers began to save rather than spend money for the first time in decades, the car business was the first casualty. No one showed up at the showroom anymore. GM and Chrysler went under.

In the past, the U.S. government allowed private companies to fall apart, confident that new ones would rise in their place. Not the bailout state. The feds already had protected the GSEs and Wall Street. Why not Detroit? The price is "only" $110 billion, compared with trillions to the banks and in guarantees to Fannie and Freddie. The Rust Belt economy, moreover, has been reeling for some time. Liquidating GM and Chrysler could wreak havoc on parts suppliers and other businesses that depend on the auto giants. Better to cushion the blow.

Political connections helped. The economist Simon Johnson wrote a long essay in the Atlantic recently in which he argued that government and Wall Street became too cozy over the last decades, giving us both the crash and the TARP. The same logic applies to the Democratic party and the UAW. There simply was no way a pro-labor Democratic president from a Great Lakes state was going to allow GM and Chrysler to vanish and the gold-plated benefits the UAW had secured over the generations to disappear as well. True, the unions will have to sacrifice some as part of the bankruptcy. But nowhere near as much as the creditors, on whose confidence markets depend.

In the bailout state, politically connected groups secure government ownership of enterprises that otherwise would go belly-up. What does Uncle Sam get in return? The ability to transform once-private companies into tools of economic and social policy. The GSEs are put to work handing out mortgages to applicants who might otherwise be rejected. The banks are forced to lend so that consumers will spend, even though excessive lending and spending is what got us into trouble in the first place. The Beltway bosses reduce executive pay at all politicized companies in order to tamp down populist outrage and pursue equality.