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The Role of Government: Keeping the Wealthy Rich

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For some reason most of the discussion in Washington and the media of the bank bailouts is overlooking their central feature: taxpayer dollars are being used to sustain the income of incredibly rich bankers. The public should be furious over this upward redistribution of income.

The basic story here is very simple. If we got the government out and left things to the market, virtually the entire banking sector would be bankrupt. Citigroup, Bank of America, Goldman Sachs, Morgan Stanley and almost all the other big banks, and thousands of smaller ones, would be out of business. (My bet is that even "healthy" banks like Wells Fargo would be in bankruptcy before too long. They hold plenty of bad debts, too.)

Most of the top executives of these banks would likely be sent packing, while those remaining would have their compensation (including "golden parachutes" and bonuses) set by bankruptcy judges who would be running the companies in the interest of the creditors, not the shareholders. The shareholders themselves would be out of luck for the most part. Many bank stocks have already lost 80-90 percent of their value over the last 18 months. Bankruptcy would likely eliminate what little remains.

However the banks are not in bankruptcy because the confused state of affairs and potential lost of creditors' wealth created by large-scale bankruptcies in the financial sector would be a devastating hit to the economy. This is the rationale for the TARP, the various special lending facilities created by the Fed, and other measures to ensure the survival of the banking system.

The government has intervened in a huge way to keep the market from taking its course. But the key issue that has been buried in the debate in the media and political circles is the separation of the interest of the public in a functional financial system and the interests of bank executives in high salaries and shareholders in getting returns on their capital.

At this point, the banks are desperate -- they would be dead without government handouts. This means that the government can set whatever terms it wants. And, for both economic and moral reasons, it has an obligation to set terms that do not reward the bank executives and shareholders.

The bank executives and shareholders took big risks that went bad. If they are rewarded with taxpayer handouts, then the message this sends to the financial sector is to keep taking irresponsible risks. The game becomes heads they win, tails we lose. If the bets pay off, then they are incredibly rich. When the bets go bad, the taxpayer gets the tab.

The moral reason for not rewarding executives and shareholders is that these rewards require the taxation of middle income people, like truck drivers and nurses, to transfer money to some of the richest people in country.

This sort of upward redistribution is difficult to justify. Usually people in the United States like to believe that the market determines the distribution of income. Many get outraged over the idea that a mother on TANF can get a check for a few hundred dollars a month from the government. In this case, the government is effectively handing checks of millions of dollars to bank executives who would be out of work if the market was left to run its course.

We have to keep the financial system functioning, but we can do this without transferring hundreds of billions of dollars from middle class taxpayers to the wealthiest people in the country. If the bailout conditions imposed by the Obama administration and Congress don't effectively eliminate shareholder wealth in the bankrupt banks and bring compensation (in whatever form) of bank executives back down to main street levels then it is can only be explained by corruption. There is no excuse for this massive intervention to redistribute income upward.