Lately, we have been discussing in my classes that a necessary, although not sufficient policy question concerning bailout economics is whether the bankruptcy of a given firm creates a systemic risk with effects which go well beyond the direct stakeholders (e.g., shareholders, creditors, employees, suppliers, customers) of the firm in question. Based upon this criterion, I think that a logically coherent case can be made for infusing capital into commercial banks as part of a risk management strategy designed to prevent a financial contagion which could take down the entire economy.
However, when we look at GM, Ford, Chrysler, etc., it isn’t clear to me that these firms pose a substantial systemic risk. In the case of the U.S. auto industry, I think that it would make sense to let these firms go through bankruptcy, which would enable them to abrogate and renegotiate existing contracts, sell off or liquidate parts of their businesses that don’t make any sense, and reorganize so that they can come out of bankruptcy with sustainable business models. All that a bailout does now is to encourage the continuation of a broken business model, including things like the UAW job banks which comprise workers who get UAW negotiated compensation in exchange for not producing any automobiles. I take this as prima facie evidence that there is way too much overcapacity in the US auto business as it is currently structured.