Once the government passed the $700 billion bailout for the financial sector, it was inevitable that virtually everyone else’s hand would soon be out asking for a piece of the near trillion-dollar giveaway. 

Municipal and state bond insurers, for example, now have their hands out, saying that they are as important to the financial health of the economy as any of the banks that the government is buying into. They are asking for up to $1.4 trillion in state and municipal bonds to be guaranteed, along with, perhaps, an additional $900 million in corporate and other debt they insure.

Wednesday, October 29, the governors of Michigan, Delaware, Kentucky, New York, Ohio and South Dakota sent a letter to Treasury Secretary Henry Paulson asking that a fair share of the multi-billion dollar largess go to the struggling American automobile industry. “Hey, brother, can you spare a few billion dimes for General Motors and Chrysler?” 

And, also, it seems that negotiators for the Federal Deposit Insurance Corp. and the Treasury Department are deep in consultation to put together a program to guarantee the mortgages of delinquent homeowners. Between $40 and $50 billion out of the $700 billion might be used to subsidize as many as three million homeowners who could not meet their mortgage payments. 

The unofficial reports say that the government will offer a deal to the financial companies holding the titles to these mortgages. The companies would be expected to lower the interest rates on the loans, stretch out the payment schedule, and even reduce the principle owed on the home. In return, the government would cover half of any future losses that mortgage companies may incur if the homeowner ended up defaulting. 

As The New York Times explained, suppose that $500 billion in home loans were renegotiated along the lines wanted by the government. And suppose that in spite of this, 25 percent of these homeowners were still to default, and losses on these foreclosed homes came, say, to 45 percent of the value of the loans (or $56.3 billion on the $125 billion in default). Then, the government would be expected to pay out to the mortgage companies $28.1 billion (or one-half of the value of the loss). The greater the default rate on these guaranteed renegotiated mortgages, the higher the government’s liability to make good on half the loss. 

As one lobbyist said to The Washington Post, “Everyone has their hand out now. It’s a lot of money, and people are hurting.” 

In the mania for a portion of the bailout billions, no one is realizing that a serious and dangerous precedent is being established that may reverberate for years or decades to come. 

Economists call it moral hazard. If you subsidize bad or risky behavior, you end up creating a perverse incentive for the same bad and risky behavior in the future. Suppose Johnny runs his car into a tree and racks up so much on his credit card that he is unable to keep up with the minimum monthly payments. And suppose that Mom and Dad step into the breach, and pay for the car repairs and pay off his credit card. 

What lesson is Johnny likely to learn from this?  We should not be too surprised if he concludes that no matter how reckless he is in the future his kind-hearted parents would always be there to bail him out. As a result, he would continue to drive unsafely and give into the temptation to irresponsibly purchase on his credit card whatever caught his fancy. 

This is what the United States government is doing as paternalist guarantor of potentially trillions of dollars of bad decisions made by millions of people throughout the economy. Get over-extended on your credit card? Take out a home mortgage you really can’t handle unless the price of the house goes up in the near future so you can resell it? Lend to borrowers whose credit worthiness is a bit dubious? Cover the insurance on policies and investors whose prospects are unusually high risk? 

Do not worry; the government is there to see that your misfortune is covered at the taxpayers’ expense so the country as a whole is not destabilized by your folly. We already know the mantras: “Too big to fail.” “Essential to the health of the economy.” “The source of jobs crucial to the society.” “Important to national security.” The list goes on-and-on. 

Once the precedent is in place for the expectation of such bailouts, and once the government subsidized guarantees are in full swing, who will fear the consequences of their own mistakes? What politician, thinking of his upcoming reelection campaign, will want to give his constituents the “bad news” that the government safety net against private losses is going to be reduced or even ended? 

An entire new entitlement will now be in place: the “right” to be protected from ever bearing the cost of errors, mistakes, and rash and irresponsible decisions. Matching this will be a special entitlement industry of lawyers and lobbyists paid by all the various groups and industries covered by the guarantees to see that everyone gets what is “rightfully” theirs; and to make the case for expanding the benefits at the political bailout trough. 

Of course, those who are handing out the bailout billions have to assure the taxpayers, “to whom they are responsible,” that the money is not being “inappropriately” used. So coming with the money will be a new bureaucratic spider’s web of rules, standards, requirements and qualifications. The micromanaging hand of big government will accompany the paternalistic bailout payments.

Seeing to it that similar mistakes are not made in the future will not be achieved by rewarding those who have made these bad decisions. This requires that agents in the market bear the losses and the costs of their miscalculations and misguided decisions. 

The alternative is a further reinforcement of irresponsibility among the citizenry. This is a policy that not only ends up extending government power over the populous, but weakens the character qualities in people without which a healthy and freedom society cannot long survive.