The $23.7 trillion bailout's biggest message: Fail catastrophically
Jul 25th 2009 10:45AM
Updated Dec 4th 2009 6:46PM
What does America value? The answer is simple: building the biggest and riskiest companies in the world. If you achieve world-class levels of size and risk, the U.S. government will use everything in its power to rescue you if you get into trouble and let you pay yourself billions in bonuses if things are going well. With $23.7 trillion of taxpayer money at risk to bail out those huge institutions -- almost twice U.S. GDP -- there can be no doubt how great the reward is for failing big.
This spells trouble for 99.9 percent of the businesses in the U.S. If the failure of your business will not cause a so-called systemic risk -- namely costing trillions in losses around the world or throwing millions of people out of work -- you are on your own. This comes to mind in considering the latest test case of the too-big-to-fail idea -- CIT Group (CIT) -- which, despite raising $3 billion from its biggest debt-holders, appears headed into bankruptcy.
How so? The FDIC does not want to let CIT move its riskiest assets to its Utah banking subsidiary because it believes that this Utah bank will use hot money to finance itself which will ultimately lead it into the arms of the FDIC. And given that CIT does not hold systemically risky toxic waste -- such as mortgage-backed securities (MBSs), collateralized debt obligations (CDOs) or credit default swaps (CDSs) -- its failure can be contained and thus is not worthy of U.S. intervention. Simply put, CIT did not take enough risk to warrant a U.S. rescue.
It may be good news that CIT will not spur another bailout -- even though it probably would need a mere $6 billion to save it from bankruptcy -- which is tiny in the grand scheme of things. As I've posted, one of the implicit obligations of those big Wall Street banks that have repaid their TARP money is that they must pick up the rescue slack which the U.S. government wants to leave behind.
But the biggest message of the $23.7 trillion bailout is that America has two economic systems: one which 99.9 percent of the companies inhabit and another which only the top handful of companies enjoy. The U.S. is sending a strong signal that it thinks that second system is better than the first.
How so? Rather than rewarding the kind of entrepreneurial activity that makes America a magnet for talent -- the first economic system -- the message of the bailouts is that it's better to be part of the second system. That's because the U.S. is saying through its bailouts that if you want to make money in good times and bad, the best thing to do is build a company that is bigger and riskier than all the rest.
Although I am happy to see that CIT will not get yet another U.S. bailout, I fear that the $23.7 trillion bailout's message -- fail catastrophically -- is exactly the opposite of what we need to get out of the current financial funk.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He has no financial interest in the securities mentioned.