The Risk to Other Companies from Government Bailouts

The Motley Fool has a decent article which mentions the riskiness involved in these bailouts. It’s great that the Federal Reserve gets to pick and choose which companies live and which ones die. Leaving them alone might kill that company, but giving one an unfair advantage by handing it billions of dollars is sure to hurt its competitors. So, while you may have saved one big company from extinction, how much are you going to hurt similar companies who made wiser decisions and aren’t in dire straights?

Remember the good ol’ days, when the size of government bailouts was measured in mere tens of billions of dollars? You know — back in March? That’s when the U.S. Treasury facilitated JPMorgan Chase’s (NYSE: JPM) takeover of Bear Stearns by guaranteeing $29 billion in troubled mortgage-related assets on Bear’s books.

The good news is that the rescue was successful — the financial system suffered no mortal wound. For JPMorgan Chase shareholders, the news was even better; the bank walked off with Bear for a song. The bad news, for U.S. taxpayers at least, is that the value of Bear’s portfolio has fallen since then. The Federal Reserve recently announced that it (or you the taxpayer, effectively) has a $2.7 billion paper loss on its commitment.

While I do think the government will ultimately record an aggregate gain on its investments in institutions such as JPMorgan Chase, Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC), this is a reminder that the government’s $700 billion bailout program is far from riskless.

There are two morals here: First, when you guarantee the value of a portfolio of dodgy assets, you should ask for something in return. Not demanding warrants from JPMorgan Chase was a mistake.

You really want to expand the bailout?

Second, this episode and AIG’s (NYSE: AIG) blistering drawdown of its initial $85 billion government loan should serve as obvious warnings to the government, as it reportedly mulls over whether or not to expand the scope of the bailout program to non-banks such as GE Capital, a unit of General Electric (NYSE: GE), or CIT Group (NYSE: CIT). Free-market champion Friedrich Hayek must be spinning in his grave.