The Other Epidemic Plaguing Washington: Bailouts and Moral Hazard

While lawmakers face tough decisions about the economic impact of coronavirus, they should keep in mind that they face battles on two fronts. They want to promote a healthy economy (or as close to one as is feasible) during the coronavirus downturn, but they also don’t want to exacerbate moral hazard.

Moral hazard reared its ugly head during the 2008-09 recession, particularly in the form of the infamous (and unpopular) TARP program. The concept holds that policy actions supporting people who engaged in “bad” behavior—for instance, bailing out the Wall Street firms that caused the financial crisis—will only encourage such behavior in the future. Multiple examples in recent days, featuring both corporations and individuals, suggest the concept remains alive and well in Washington.

Corporations and Buybacks

On the corporate side, individuals as varied as Rep. Alexandria Ocasio-Cortez (D-NY) and billionaire investor Mark Cuban have highlighted prior actions by airlines, who now seek a government bailout totaling $50 billion. Both noted that the airline industry as a whole spent 96 percent of its free cash flow over the past decade buying back shares—an act that might juice company stock prices, while leaving little cash on hand should a major calamity like a pandemic emerge.

Some have argued that because the Internal Revenue Code currently taxes corporations’ accumulated earnings, airlines have a strong disincentive to build up larger “rainy day funds,” notwithstanding the historically volatile nature of their industry. But the optics of this potential bailout reek of moral hazard, by privatizing gains (i.e., stock buybacks) and socializing losses.

Student Debt

The issue of moral hazard has not remained confined only to corporations. For instance, Sen. Elizabeth Warren (D-Mass.) has demanded that Congress include “broad student loan forgiveness,” along the lines of her presidential campaign proposal, as part of any “stimulus” legislation.

That student loan bailout proposal, originally released in May 2019, “cancels $50,000 in student loan debt for every person with household income under $100,000,” and “provides substantial debt cancellation for every person with household income between $100,000 and $250,000.”

That type of proposal has all sorts of flaws to it. Most notably, by rewarding individuals who picked costlier, private institutions (e.g., Harvard University), it punishes those who chose a less expensive school (e.g., a public institution or community college) to save money. It likewise punishes those who chose their degree based upon earning potential (e.g., an MBA) compared to those who decided to study what they love, even if it would not help their future earning prospects (e.g., art history).

Of course, such a massive (and expensive) bailout would have little to do with the immediate task at hand, in the form of the virus’ economic impacts. A household with income last year of $80,000, but where the income-earners telework, would receive far more debt forgiveness than the owner of a restaurant who earned far more last year but whose small business now lies in ruin because of the virus.

One can cite the present circumstances to make a case for some student loan assistance. Forbearance, a waiver of interest, and suspension of collections—all make sense, particularly for families suffering financial turmoil. But outright loan forgiveness? That would only exacerbate the rising cost of college education, as future students would spend away, thinking Washington will erase their debts in a similar fashion.

Don’t Pick Winners and Losers

Various publications have noted that the “stimulus” activity represents a bonanza for K Street. Lobbyists continue to make their pitch for bailing out various industries, and using coronavirus as a justification to enact agenda items that existed well before the epidemic.

But Congress should avoid the temptation to enact bailouts targeted at particular industries. Such activity only picks winners and losers, further entrenching Washington in the nation’s economy. Moreover, some of the industries seeking assistance have a less-than-critical role in the nation’s economy.

Cruise lines—most of whom base their ships in other countries anyway—how do they represent a vital national interest? Casinos—does anyone really think Americans won’t want to gamble again once the coronavirus restrictions get lifted?

Lawmakers always feel the need to “do something,” seemingly irrespective of what that “something” is. The current pandemic only exacerbates that dilemma. But Congress should proceed very cautiously, because the “cure” for the coronavirus economy could in the long run end up worse than the disease.

This post was originally published at The Federalist.