Tuesday, October 07, 2008

Rent Seeking and Bailouts

Rent seeking behavior is using resources to claim "free money" or economic rents. Rent seeking causes what are called "dead weight losses", wasted resources, because free money is available to claim.

Taxpayer money given out to private enterprises is one form of "free money". As financial companies recognize that free money is available they turn their attention away from saving themselves by raising capital, doing deals that make sense, and running their businesses towards grabbing a piece of the political pie, lobbying for a bigger piece, and paying off the political class in Washington.

We saw this behavior as Lehman Brothers potential acquirers dithered looking for a Bear Sterns style guarantee. We see it with Citigroup getting a taxpayer handout to acquire what turned out to be a very valuable Wachovia. To review, taxpayers took on billions of liability so Citigroup would buy Wachovia for around 2 Billion dollars. Wells Fargo offered 16 Billion without taxpayer liability! In short, taxpayers were getting screwed to the tune of billions for the benefit of the well connected, privately owned Citigroup. It turned out Wachovia shareholders were getting screwed too. Citigroup even has the gall to sue to protect their taxpayer funded purchase!

More evidence is in the Bear Sterns bailout. Taxpayers took on bad debts in a deal where stockholders appropriately for a a failing firm got very little. Stockholders pushed and got more. Taxpayers didn't get a better deal! The deal was more about getting taxpayer free money than ding the economically best deal.

Unfortunately, a lot of smart, hard working people working at financial companies are going to be spending their time, effort, and money maximizing their share of taxpayer's bailout money instead of doing anything that creates wealth.

That deadweight loss is one reason market reaction to the bailout has been so negative when it was proposed, when it failed, and when it passed.

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