With a Detroit bailout, the Fed may become too invested to quit
It's called the behavioral trap. And it's curable.
I'm thinking of selling my shares of AIG. They're just not performing the way the government promised when they purchased them on my behalf. Maybe I'll get some shares of GM instead.
Just as we taxpayers are the owners of some floundering financials, we may also soon own pieces of the Big Three car companies.
The bailouts have been on everybody's lips lately (perhaps second only to speculation about the Obama family dog). Whether for or against, both sides of the debate have been using slippery slope arguments to defend their view.
On the wayward side, the argument goes, a Detroit bailout would spark a frenzy reminiscent of fish pellets in a carp pond. Credit card companies will demand a share; whole cities are already holding up cupped hands; makers of the dog polisher, mesh raincoat, and electric banana straightener will need some help.
On the leeward, let the auto industry slip into oblivion and myriad other industries will tumble down after it. Before long, the entire economy will be in a heap at the bottom.
The aftermath of either scenario looks more like a black hole that even experts can't hope to illuminate than resolution.
But what is certain is that should Detroit (or any others) get the bailout go-ahead, the Fed will find themselves headed straight for a behavioral trap.
The behavioral trap arises after a once-hopeful course of action becomes undesirable and difficult to escape from.
The tricky part is that, while it's possible to abort the mission should things go wrong, prior investments lead people to make decisions they otherwise wouldn't.
You want out, but at every point of decision – continue or withdraw? – you look back at the work you had to do to get there. Wasting it is a painful prospect, while one more step – one more investment – just might do the trick.
Calling Dell customer service is a behavioral trap. One more "Your call is important to us," and I'm hanging up. "It can't be much longer now," we reason. And so on. The longer you wait – the bigger the investment – the harder it is to hang up the phone.
The Iraq war is another behavioral trap. Nobody expected it to last this long or cost this much. The US entered in an environment of volatility and instability – when the consequences of inaction were unthinkable, when something had to be done and done quickly – with little discussion of the "what ifs" that might snare us along the way. (What if it drags on for eight years and $3 trillion? What if thousands lose their lives?)
Now, amid the current economic crisis, in an environment of volatility and instability, when the consequences of inaction are unthinkable, something must be done, and done quickly. But what if?
What if $25 billion isn't enough for the auto industry? Are we prepared to inject more, indefinitely? To clamp another ball and chain onto the ankle of our crippled economy? AIG, clamped since September, has the Fed on a monthly payment plan – and still the toxic debts swamp their deck (while the captains have formed a conga line on a luxury liner somewhere). Or, if $25 billion isn't enough, are we prepared to walk away and waste our investment?
The consequences here are slightly more dire than wasting an afternoon with Dell. We need a plan in place. Thankfully, there are some steps we can take to help escape or avoid behavioral traps.
1) Whoever made the first decision, has an interest in being vindicated, and should avoid making subsequent decisions.
2) Reassessments of whether to persist or pull the plug must be made independently of prior investments. Regardless of the two hours I just spent on hold, if I came across myself at this moment – bladder about to explode, only a yawning silence on the other end – would I hang up?).
And, to avoid future traps:
3) Before taking a course of action, one must explicitly consider the costs of continuing it, and the costs of abandoning it, should things turn sour.
Today the industries are too big to fail. Tomorrow it may not matter whether we're saving the Big Three or the maker of the mustache guard. After another bailout the Fed may be too invested to quit.