Nats to bail out big business?

I was slightly concerned when I saw the headline on stuff this morning “Nats eye bailout of big business”

If the government is saying ex ante that they will bail out big businesses I would be concerned as this has the potential to cause a moral hazard problem. This is where firms know they will get bailed out and thus make riskier decisions. The actual quotes from Bill English don’t appear the be as explicit as I originally thought they might be

“You’re in an environment when almost anything any government could contemplate doing is getting done somewhere in the world,” he said.

“There is a small chance that events that have transpired elsewhere could transpire here. You can’t ignore that and so we need to give some thought to the extreme event.”

Are quotes like this enough to give the big companies in NZ enough comfort that they will bailed out? Only time will tell….

  • Effectively we have to ask – how much does insurance on “tail risks” influence firms decisions to take on riskier investment?

    Without some knowledge of what sort of plans Bill English wants to make, I can’t really say much about how this influences firms investment choices.

  • The government should be explicit about NOT bailing out anyone.

  • “The government should be explicit about NOT bailing out anyone.”

    That would definitely remove the moral hazard problem – but it would also prevent the government from acting in the face of market failures – specifically those stemming from asymmetric information.

  • That’s the problem I guess, we want to be able to act if firms go under because of a market failure, but at the same time we don’t want firms to undertake risky investments becuase they know they will be bailed out.

    It seams to me we can’t have both so we need to decide which is more important, I’m undecided which is worse at this stage!

  • “It seams to me we can’t have both”

    Isn’t that assuming that we have a discrete choice when it is actually a continuous choice – as a result we just need to look at the appropriate margin. We can have a small inefficiency from moral hazard behaviour and have flexibility to react to large market failures can’t we?

  • Would we do that by making a public commitment not to bail anyone out and then go back on it if someone really big goes under?

  • “Would we do that by making a public commitment not to bail anyone out and then go back on it if someone really big goes under?”

    Huh, I wasn’t meaning to say that we should go back on our word – I mean’t that the government could try to commit to a continuum of different combinations of (moral hazard, flexibility) where the greater the flexibility the greater the moral hazard.

    I definitely don’t think that the government should lie – as that destroys credibility. I think maybe we got our wires crossed here and are actually agreeing 😛

  • Bob Higgs’ work on regime uncertainty seems more and more relevant….

  • “Bob Higgs’ work on regime uncertainty seems more and more relevant”

    No-one wants uncertainty – which is why a transparent threshold for bailouts should be set, if the government feels that there are situations where they can help.

    The issue at the moment is that government can’t seem to commit to any set level – they act like they will do nothing, but then when anything happens they run around like a headless chicken (hence why so much of the US policy is currently termed ad hoc). This is a bad thing.

    This doesn’t mean that a pre-determined bailout threshold could be a bad idea (it doesn’t mean it could be a good idea either) – but it does mean that governments ability to commit itself to a certain action plan hurts a nations welfare.

    Government needs to learn to see itself as a structural variable – they need to set transparent rules that occur. However, the political process rewards constant “change” and “trying to do things” – exactly the sort of variability you don’t want in the structure of the economy during a time of uncertainty 🙂

  • Agreed, a threshold is good in that in provides certainty, but the flipside of that is that if you are above the threshold you have certainty that you will be bailed out:)

  • “Agreed, a threshold is good in that in provides certainty, but the flipside of that is that if you are above the threshold you have certainty that you will be bailed out:)”

    I guess the risk could be:

    – if you are going to f*ck things up, you should f*ck things up to a big degree 😉

    As a result, the magnitude of the “bailout” will matter as well.

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  • steve

    Don’t make the threshhold explicit.

    Simply say if there are any bailouts, it will only be where the government considers it necessary for the overall health of the economy. A statement like that means businesses can’t expect to be bailed out but it still allows the government to help out in a market failure.

  • “Don’t make the threshhold explicit.

    Simply say if there are any bailouts, it will only be where the government considers it necessary for the overall health of the economy. A statement like that means businesses can’t expect to be bailed out but it still allows the government to help out in a market failure.”

    Necessary is quite a subjective term that in itself implies a threshold – if you make what is “necessary” explicit then firms and households have more certainty when making decisions.

    Note, being able to commit to a higher threshold to bailouts would actually reduce moral hazard compared to the current “implicit” policy.

  • It would be quite fun to see what kind of internal analysis gets done at all the big corporates to try and work out if they “neccesary for the overall health of the economy” 🙂

    In this kind of situation most companies would have to operaoe under the assumption that they aren’t (expect for Air NZ and Fonterra) which is porbably a good thing.

  • steve

    “In this kind of situation most companies would have to operaoe under the assumption that they aren’t (expect for Air NZ and Fonterra) which is porbably a good thing.”

    This was my point, by being so vague, they would almost eliminate the moral hazard problem.

    Another consideration may be the form of a bailout. A bailout that involves nationalising a company (not that I favour this option) and replacing senior management is surely not desirable for any executive.

  • “This was my point, by being so vague, they would almost eliminate the moral hazard problem.”

    They can only eliminate the moral hazard problem by being able to commit to NOT intervening. If they “might” intervene businesses will put some probability on it.

    As a result, they can state that the tail probability of a bailout is lower than businesses implicitly expect – implying that telling people directly what the parameters are reduces the amount of moral hazard activity.

    “Another consideration may be the form of a bailout. A bailout that involves nationalising a company (not that I favour this option) and replacing senior management is surely not desirable for any executive”

    Indeed, the form of the bailout and the balance of control in an organisation are other essential issues that need to be taken into consideration when deciding on policy. However, I think this is why certainty of any bailout is so important – as it definitively structures it in the best way prior to any crisis.