Hempton’s Law of the Conservation of Subsidy

By Felix Salmon
April 2, 2009

John Hempton has a nifty piece of logic demonstrating that it doesn’t make sense to bellyache about the implicit subsidy in the Geithner bank bailout plan. It’s worth reading the whole post, but basically he’s saying that the subsidy only really kicks in when the banks are insolvent, and since the government has promised “no more Lehmans”, insolvent banks are going to be receiving generous dollops of government subsidy in one form or another anyway.

Call it Hempton’s Law of the Conservation of Subsidy: Subsidy can neither be created nor destroyed, it can only be changed from one form to another.

I think John might be on to something here, but I still think there’s a strong case to be made for maximizing the transparency of any government subsidy to the banking system. The critics of the subsidy implicit in the Geithner plan aren’t in general critics on the grounds that it constitutes excessive government spending — we’re mostly supporters of the stimulus package, for instance. Rather, my problem with the implicit subsidy is more about the “implicit” part than the “subsidy” part. If you’re going to subsidize the banks, let’s make it very clear which banks you’re subsidizing, and how much you’re subsidizing them by.

This is all connected to the nationalization debate, of course. Every time the government throws a certain amount of cash at a bank, it’s quite easy to calculate the ownership stake that quantity of money could buy, given the prevailing share price. And so you get pro-nationalization rhetoric along the lines of “we could have bought Citigroup X times over for the amount of money we’ve given them”.

If you hide that money in some combination of PPIPs and the FDIC, however, then it’s never possible to calculate how much any given bank has benefitted from the taxpayer plan. You get all the costs of nationalization with none of the upside. So it’s easy to see how a government which doesn’t want to nationalize — like this one — came up with the PPIP scheme. It might not reduce the total subsidy going to the financial sector, but it certainly reduces its transparency.

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