Sunday, December 7, 2008

Dodd's Discriminatory Bailout: "Regime Change" for Main Street, But Not for Wall Street?

What the media are not saying about the Chicago workers' sit-in:

MADE IN IOWA: Did Company in Chicago Sit-In Illegally Discard Its Workers and Quietly Relocate While Liberals Forced BOA to Pay for the Shady Scheme?

* Republic Windows and Doors Received a Bailout from Chicago Before It Bailed Out of Chicago

* Laid-Off Republic Windows and Doors Workers: Pawns in Political Football]

Regime Change in Detroit?

Senator Christopher Dodd, who chairs the Senate Banking Committee, has argued that Richard Wagoner, the CEO of General Motors, should resign before the troubled automobile manufacturer receives federal financial assistance. And this morning, he has broadened those comments to implicate all automakers: "'[I]t's not my job to hire and fire, but what I suggest is, you need to have new teams in place here . . . if you're going to convince the American public' that the financial relief plan is necessary and justified" (italics added). Dodd also believes that Chrysler and GM will probably have to merge so that both companies can survive. My question for Dodd: Why did you fail to demand "regime change" among Wall Street recipients of federal aid?

President-Elect Barack Obama was less direct when he addressed the issue. During an appearance on Meet the Press, Obama said that the issue of mandatory changes in leadership "may not be the same for all companies." At press conference following the show, however, Obama offered an additional perspective on the issue:

If the management team "that’s currently in place doesn’t understand the urgency
of the situation and is not willing to make the tough choices and adapt to these
new circumstances, then they should go. . .If, on the other hand, they are
willing, able and show themselves committed to making those important changes,
then that raises a different situation . . . .”

Although Obama refused to define what "changes" he envisions or to take a position regarding a specific company or executive, his statements together with Dodd's comments show a new toughness among Democrats towards potential recipients of federal "bailout" assistance. During the general election campaign, members of Congress engaged in bipartisan rhetorical grandstanding and promised to place numerous conditions in the bailout package. The final statute, however, gives very broad discretion to the Secretary of the Treasury (see my analysis here). Now, Democrats have indicated that they might require company executives to step aside as a condition of receiving federal money. That's very tough talk.

Why No Regime Change on Wall Street?

But I am trying to understand why replacing corporate management has only recently become a possible prerequisite to the receipt of federal assistance. The various financial institutions that have received federal assistance face poor economic conditions because they recklessly decided to engage in risky -- but lucrative -- mortgage lending, bundle those mortgages and sell them as securities, or invest in securitized mortgage assets. Citigroup, the recent recipient of the largest financial bailout to date, engaged in all of these practices through its various divisions. Flawed managerial decisions led to these bad investments and to the present erosion of available credit. If Congress wants "heads to roll" before assisting companies, this same logic should apply evenly to all economic sectors.

In many ways, however, the auto industry could be less culpable for its financial woes than the banks were for their own problems. Auto companies lend money to purchasers and probably made poor choices during the recent "easy credit" run. They can also invest in risky mortgage-backed securities. But most of their trouble today results from not having sufficient money to conduct prospective business, rather than from the unraveling of prior investments. They do not have access to credit precisely because the bank crisis has caused credit to tighten. Prospective car purchasers also face difficulty securing loans, which exacerbates the situation (see this article in Forbes on the subject and on a potential remedy). Irrational exuberance in the housing market caused most of this problem. The greatest blame lies with financial institutions, mortgage brokers, realtors, home builders, state and federal regulators, and home buyers. The auto industry does not deserve tougher restrictions than Wall Street.

Then Why Treat Wall Street and Main Street Differently?

The Election is Over
Perhaps the Democrats feel safe taking a tougher position with companies seeking federal assistance now that the election has taken place. Even though most voters disagreed with the banking bailout, they also felt that not supporting the legislation could harm the economy. The House Republicans received a fair amount of criticism for blocking the initial plan. Democrats probably wanted to avoid similar complaints.

Financial Institutions Give Much More Money to Political Candidates Than Automakers
Another, more ominous explanation for the disparate treatment of automakers relative to banks could involve campaign financing. According to research completed by the Center for Responsive Politics, Dodd, who chairs the Senate Banking Committee, tops the donor recipient list of several banking institutions. Furthermore, members of Congress who supported the bailout received far more money in campaign donations from financial institutions than legislators who voted against the bill. In the House, legislators who supported the bailout received 51% more in campaign contributions from banks, and in the Senate they received twice as much (see here and here).

Automakers also contribute to candidates, but they do not donate nearly the same amount as banks. According to data compiled by the Center for Responsive Politics, automakers split their donations among the two major parties during the recent election cycle, but they contributed only a fraction of the money that financial institutions gave (The Center for Responsive Politics website has a tool that permits readers to research campaign donations by industry.). Keep in mind that donations come from individual employees and their political action committees. Auto workers will have less money to donate on average than Wall Street bankers. Car dealers donated more money than automakers, but most of it to Republicans. Furthermore, their donations do not compete with those of financial institutions. Given the role of money in politics, it is difficult to deny some degree of industry capture with respect to regulated entities and regulators.

Update: I have not found any major media coverage of this particular dimension of Dodd's comments, but I did find this entry by Deb Cupples on the Buck Naked Politics blog. Blogs can provide a wonderful alternative to popular news sources.


Tony Nathan said...

They are all corrupt!

FLRN said...

Well stated professor, I agree with you about the root cause of the shell game played out by financial institutions in the mortgage market, and I love your definition "irrational exuberance in the housing market". But let us spread the blame around as everyone's hands are dirty here and you are right to follow the money ... Legislatures long ignored what amounts to corporate loan sharking. But let us not forget the blissful American populous hooked on overspending and being held under accountable for their poor choices. I too was disappointed by federal lawmakers that did not define a clear accountability and a clean sweep of upper management within the lending industry. Shame on them! But let's stop the madness there! What are they thinking? Now lawmakers are going to bailout the auto industry and average taxpayers are not going to get so much as a complimentary car ride here! What about the consumer? Do they hold any responsibility for the mess we face because they consistently outspend their income with no remorse all the while engaging in a foot race to Wal-Mart to over shop for a holiday season they cannot afford? What's changed here? I assert everybody needs to slow down and recognize a good old fashion recession for what it really is - a wakeup call to stop living on the margin, or else these bailouts will just continue. What's next saving the supermarket industry? - If so then perhaps we should place a lean on coupon-clipping customers? Take breath Washington - Let the industries falter for just a little while longer before taking the lid off of the federal cookie jar and rewarding the bad behavior of more corporate giants - It is too late to make up for letting the real culprits off the hook!

sirusdesign said...
This comment has been removed by a blog administrator.
Darren Lenard Hutchinson said...

FLRN - "A good old-fashioned recession" -- wow! Well, there is a lot of truth to that. The theory behind "bailing out" banks and large industry is that they fuel the economy. If they have liquidity, then the velocity of money (going back to my Econ days) increases. Giving individuals money provides direct assistance, but it does not have as large a macroeconomic impact. But beyond that theory, I tend to agree with your observation that a recession includes pain.

I think government has a role for minimizing this harm. This is a great time to discuss health care reform, social security, and the development of other safety nets. We need state involvement, private sector participation, academics, the national government....all voices.

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