What Are The Bailout Risk?

by Jay Deragon on 09/29/2008

Everyone takes some risk. Some take more risk than others. Gambling in Las Vegas has risk. Starting a business has risk. Those that take risk hope to receive the reward of their risk. Calculating and providing protection from risk is the business of insurance companies.

AIG, one of the world’s largest insurers, took risk and did not calculate the potential impact of the risk they took. Subsequently the US Government decided to bail AIG out at the tune of $85 Billion in addition to the roughly $600 billion of other financial risk gone bad by banks and Wall Street firms.

The current U.S. Government Bailout program represents a significant shift for financial markets, and for individuals and businesses alike, in that our government has now become the largest insurer in the world. However the government insurance program is unlike any other insurance offered by the private sector. The U.S. Government Insurance Program basically says to business markets, don’t worry if you fail we’ll back you up. What a deal for big business but what about small business and individuals? If a small business or a family fails financially will the government come to our rescue as well?

The Backlash of a Bailout

If you haven’t noticed already the politicians are now claiming their decisions are not considered a “bailout” rather an “insurance program” aimed at protecting the consumer from taking on close to a trillion dollars of new debt. The reason for the change in terminology is the politicians don’t want to be associated with a “bailout” rather the term “insurance” appears to be more dignified and safe. Plus it creates great spin for the media and the average consumer will simply equate this legislation to “safety in the markets” which the politicians will take credit for and stand proud for protecting American consumers and the global financial markets abroad.

The problem with the proposed plan and the attitude from our politicians is that both are fundamentally flawed in their assumptions. The basis of risk management is founded on a set of choices about risk. Individually and institutionally there are five choices one makes relative to managing risk. These are:

  1. Avoid the risk: Don’t participate in activities or endeavors that increase risk
  2. Spread (share) the risk: In the insurance world this is known as reinsurance
  3. Transfer the risk: Move the consequences of related risk for others to assume
  4. Mitigate the risk: This is usually done contractually by stating who is responsible for assuming what risk
  5. Assume the risk: This means you assume the consequences if the risk produces negative or positive results

The Wall Street firms, banks and AIG first choose to assume the risk they took which then fueled failure. By declaring bankruptcy they in essence transferred the risk for someone else to assume. The U.S. Government, and our beloved politicians, looked at the situation that their own previous legislation had created and decided the risk of a global economic meltdown needed to be mitigated by the government assuming the risk of those that had failed to manage the risk to begin with.

The problem with this thinking and the related decisions is that by assuming the risk the government is actually increasing rather than mitigating the risk. How many other banks, insurance companies and Wall Street firms will fail and expect the government to bail them out. How many “big businesses”, the auto industry has already begun, will ask the government to help them mitigate the risk of their own decisions.

The proposed “bailout” is nothing more than a band aid on a damn of rising expectations actually created and enhanced by those who think their past and current decisions can be covered up or protected from risk. The truth is their decisions are fueling the risk and related cost which will eventually fall onto the back of every consumer. The government, any government, is funded by the people and any assumption of risk falls onto “we the people”. Ultimately we the people have to provide the economics of any bailout or insurance program created by those “we the people” elect to make these decisions for us.

If we don’t like the decisions we need to unite and change those who make them. What say you?

Comments on this entry are closed.

{ 1 trackback }

Previous post:

Next post: