Republican vs. Democratic Bailouts

As I pointed out before, the plan favored by Hank Paulson is simply terrible. It will grant dictatorial powers to the Justice department, and transfer hundreds of billions of dollars of wealth from the American taxpayers to incompetent Wall Street bankers.

Does that mean that the Democrat's bailout plan is better? Yes and no, is the answer to that. In some aspects, it will clearly be better, or more accurately, it will not be fully as bad.

There are three main differences between the version favored by Paulson and the version that Democratic congressional leaders favor. One is that the Democrats want some form of accountability for the Treasury department so that they can't get away with doing anything. A second is that the Democrats want executive pay to be curbed at companies that receive this subsidy. A third is that the Democrats want to insert other forms of spending into this legislative bill, such as extended unemployment insurance and subsidies to prevent foreclosures. Some left-liberal pundits, such as Paul Krugman, also wants the government to receive shares in the companies the government help, and now it appears that some Democratic congressional leaders are adopting this idea too.

With regard to the demand for accountability, the Democrats have the better proposal, clearly. Giving a government agency a blank check to do whatever it wants without any overview is not just a bad idea, it's creepy.

With regard to the demand for curbs on executive pay, that seems reasonable too given that these companies receive government aid. However, what would really be needed would be some retroactive curbs. Curbing pay now won't do much about the moral hazard created by the massive bonuses and severance packages awarded to executives whose decisions created multi billion dollar losses. Since these curbs will likely be gone by the time of the next boom, the lesson for executives is that they can earn enormous sums by making risky and stupid investment decisions. Had the banks gone bankrupt, it would have been possible under current bankruptcy law to take back at least the bonuses of executives, but now that they are bailed out that will be very difficult.

On the spending proposal, the Democrats are worse than the Republicans. While it may seem just that more than just Wall Street bankers should receive government aid, this implies a further damaging increase in the already too high government spending and deficit level.

With regard to the proposal that the government should receive ownership in the bailed out firms, just like in the cases of Fannie Mae,Freddie Mac and AIG, this has both good and bad sides. The good part is that this will reduce the redistributive effect and for that reason also limit the moral hazard effect. Still, it will not come even close to eliminating any of them because not only will creditors and former executives be bailed out, but shareholders will still benefit, only somewhat less so than under Paulson plan. The bad part is that further increasing government ownership in the economy will unless the stakes are later privatized further increase government control of the economy, which would be bad for both liberty and long-term economic efficency.

To summarize, both the Republican and Democratic bailout plans stink and should be discarded. While the Democratic plan is in some aspects less bad, they are in other aspects worse.

As usual, the only politician with a sound approach is Ron Paul.