Ranting with Reason, By David Vinnikov

I just read a NYT op-ed that I found very interesting. It states as follows:

“In the ‘90s, broke state and city run transportation services, like the Metropolitan Transit Authority (NYC) and SEPTA, needed cash. The economy was good, but they were in constant budget troubles for the same reasons they are today (unions, zero innovation, fiscal carelessness etc.) Since these organizations need cash actively, they looked for it. No takers came, seeing their poor economic state.”

The government came in and said “tax breaks for anyone who does leasebacks.” A leaseback is when I take ownership of assets for some time, collect interest, and then hand the asset back to you after some time. No one wanted to do this with defunct companies like the MTA, because no one wanted their worthless railroad cars and tunnels. They were a sure loss, at least until the government guaranteed profit.

The 90s are sublime because the growing economy covers up problems. The chief financiers of these leasebacks are big, big banks. Banks get guaranteed profit, government transport agencies get their cash flow for nothing (while keeping all needed control of their rail cars), and the growing economy covers the taxpayer’s share. Life is good.

Economic turmoil now enters the scene. The collapse of 2008 is reality and large banks (most prominently AIG) go under the waves, meaning that the people they were supporting go under too.

The correct economic action for a company in such a time is to call back the liabilities in your balance sheet, since all the assets are pretty much up in smoke. As you know, a balance sheet that doesn’t have assets equal its liabilities is a recipe for disaster. It is in fact, impossible. So AIG decides it wants to exercise its right to call back these contracts, as they have all expired, and try to save itself and become free from taxpayer cash. Selling “leasebacks” means that transport agencies pony up the interest cash they owe after getting to use railcars and tunnels for free the past decade (along with nice, subsidized access to international capital markets, courtesy of AIG, which does it courtesy of US Federal Government).

This is really bad news for SEPTA and MTA. They already have no cash, and AIG exercising its legal right to use its contracts would destroy them. Services would get hammered and balance sheets would be in worse shape than they were already.

So what are the options for resolution? Obviously this use of law and fiscal sense is not in our current interest. The government steps in to protect its baby brother, quasi-government. Those like NJ Senator Menendez, whose state owes $150 million, say “Let’s have a 100% tax on all leaseback earnings.” With a Democrat Congress already angry with the AIG monster is created, this call is taken up heartily. 100% taxes can be imposed on behalf on little Johnnie MTA at any time.

Let’s say AIG gets upset and says, “this is ridiculous, our contract is backed by the basic law of this country, and we want our money. Taxes or no taxes, we will pull the trigger, because we are trying to stay alive just as badly.” Government comes in and says “No way. MTA and NJT are my favorites, and I won’t let you hurt them. If you do anything I’ll just pull your TARP money, and then you’ll really be in trouble.” AIG, and hundreds of companies like it who didn’t take TARP, can’t afford this public condemnation by the government and back off.

MTA continues to run broken, eating taxpayer money. AIG, unable to take the needed steps to fix itself, eats taxpayer money. Neither can break out of the lock; they are totally interwoven by government policy, and will head to the grave together. Neither NJT nor AIG can afford to lose the $150 million at stake between them. Both rot, crippled by inability to get money (since both have a credit rating of zero and government promises of “Workers before debtors”) or pay it. Both industries, billions of dollars in value, sink to the sea floor, anchored by government.

Can government stop this? No. No one will want to ever risk the repercussions of letting one or the other fail. While the benefits of letting the economy go to work naturally are great, no one can stomach short-term failure. Every representative is afraid his district will be the one hit. The individual representatives from the districts affected threaten boycott if they are harmed. The larger assembly cannot fight it. Why?

The reason: in a democratic welfare state the power distribution is skewed. 51% of the vote wins you all the marbles, while 45% is a blowout. Roughly 15-20 states suck up all the cash. They each end up giving 5-6%. Interconnected companies like MTA are even more vulnerable. Giving up any one state or district for the obvious good of all 50 is a straight ticket to 45% from 51%. Government is helpless to break anything.

Government traps all three parties. No one can cut off a finger to save an arm so to speak. Billions of dollars are quite literally allowed to go utterly unused, as no one can use the money due to government favoritism and unenforced law.

What are the solutions to this bind? Voting won’t work, because while giving out 100-dollar bills to everyone is bad, you won’t say no if it’s offered to you. Everyone wants more for himself. Since no one can properly solve the financial situation, having the Fed print cash and hand it out to everyone who is owed money might work. However, that is a quick fix, which destroys the economy long-term through false incentives and inflation. Everyone can act knowing Uncle Sam will clean up the mess. An alternative is authoritarianism. No Republicans, no Democrats; just one party and one leader who decides what is right and wrong.

Am I paranoid? Not really. Extend this to banks, autos, traditional government work, and anything else our heart desires on a full economy-wide scale and this happens everywhere. What the free market would have cleaned up instantly the government prolongs and deepens hundreds of times over. Government entities (transport) negotiating with government entities (banks) overseen by government (playing itself) cannot possibly lead to anything other than this.

Related posts:

1. David de Ferranti: Innovative Health Financing Entrepreneur
2. “How to Write a Persuasive Policy Proposal” with David de Ferranti

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