INSURANCE SCHEMES, FORMAL AND DE FACTO
One of the overriding trends in corporate welfare in recent decades has been the socialization of risk. In making risky investments -- some socially desirable, some not -- and sometimes undertaking reckless activities, investors are attracted to the prospect of high returns on investment. But corporations are increasingly brazen about foisting the risk of failure -- the very reason for high returns -- on taxpayers and consumers.
The drive to socialize risk while privatizing profit is evident in the corporate drive for tort reform, the tobacco companies' effort in recent years to limit their civil liability, and in the vital importance that business attaches to government insurance schemes, formal and de facto. Among these are: the International Monetary Fund, the Exchange Stabilization Fund (ESF) and the insurance scheme of the Price Anderson Act.
Given the existence of a thriving private insurance market, there should be some skepticism attached to claims of necessity of any public insurance scheme. Certainly, there are cases where public insurance programs, voluntary or involuntary, may be merited. Where there is a public interest in guaranteeing industry survival and stability, for example, public insurance schemes may be sound public policy, especially where there is a likelihood of government bailout in the event of major industry liability or failure. But even in these cases, there should be a strong presumption of full-cost recovery and the imposition of reciprocal obligations from the insured, upon whom significant benefits (e.g., public confidence) are conferred by public insurance.
Where there is a viable alternative private market, and no clear public interest in industry protection, hard questions should be asked about the appropriateness of public insurance: What is the need for a public insurance alternative in such situations? Does the government do more than provide a subsidized service? Does the government serve as an insurer of last resort -- and if so, is this a beneficial public policy or one that merely provides an additional welfare support to other insurers? What public interest is served by government involvement in this area of insurance provision? Does it encourage imprudent investments and actions? Why should the government charge less than market rates for the insurance it provides? Is it a lead in to later government bailouts, as has been the case with banks?
THE IMF AND THE ESF
The IMF is an international financial agency located in Washington, D.C., that helps debtor countries overcome balance of payments deficits. It makes loans to countries, conditioned on those countries adopting a policy package known as "structural adjustment." In recent years, the IMF has expanded its traditional function to function as a de facto insurer of the global financial system, making massive loans to countries that suffer from sudden withdrawals of international capital.
The Exchange Stabilization Fund is an off-budget account controlled by the Secretary of Treasury. Congress established it to enable the Secretary to defend the dollar in the event it lost an excessive amount of its value relative to other leading currencies. In recent years, the Secretary has made very large draws on the ESF to fund U.S. participation in bailouts of countries that are suffering from financial meltdowns.
The vast shifts in international financial capital which have characterized the global financial markets in the last decade have resulted in episodic crises when currency traders, operating in herd-like fashion, suddenly act to pull money out of an economy. These are typically national economies in which there has been a recent, prior infusion of foreign capital in a speculative frenzy. In the last five years, the most severe of these crises have occurred in Mexico, South Korea, Thailand, Indonesia, and Russia.
In simple terms, the selloff of a country's currency forces its devaluation, making it relatively more expensive to pay debts owed in foreign currencies, and leaving the country with massive debt payment obligations that it is unable to meet.
When individuals are unable to pay their debts, of course, typically the debtor and the creditor share the pain. Through bankruptcy or otherwise, a process of work-out occurs, with the creditors receiving less than full repayment. This equitably distributes responsibility for overborrowing to the debtor and to the creditor for imprudent lending.
No such thing happens in international financial markets. When countries are suddenly unable to meet their payment obligations, the IMF rushes in. It provides money to the borrower, often in packages which include large contributions from the ESP. This money is used to repay creditors, letting them off the hook. The pain is borne exclusively by the borrowing country, which must accept recessionary austerity conditions (including tax increases, harsh budget cuts and government layoffs) from the IMF as a condition for the bailout of its private creditors.
Of course, the story varies from bailout to bailout, but this is the essential process.
In 1995, the Clinton Administration orchestrated a nearly $50 billion bailout of the Wall Street interests which stood to lose billions with the Mexican peso devaluation. The centerpiece of the bailout was $20 billion in currency swaps, loans and loan guarantees from the ESF. The IMF (in which the U.S. maintains an 18 percent share) contributed almost $18 billion to the bailout. Not all of the $50 billion was used, and what was used was paid back, but that does not affect the character of the Administration's action as providing after-the-fact insurance.
The peso devaluation was necessitated by Mexico's chronic balance of payments deficit, but the severity of the devaluation and subsequent crisis stemmed from the Mexican government's long maintenance of an overvalued peso. Fully aware of the peso's overvaluation, [53] foreign lenders and short-term investors continued to flock to the Mexican market because of its high, 18 percent interest rates. When the inevitable devaluation occurred, investors pulled out en masse. Rather than letting Wall Street accept responsibility for irresponsible lending, the Clinton Administration, with the help of the IMF, orchestrated the bailout.
The Mexico crisis repeated itself in Asia in 1997. Foreign investors and lenders poured money into the Asian tigers to take advantage of very high interest rates and returns, and then withdrew in herdlike fashion when the bubble burst. With South Korea, Thailand, the Philippines, Malaysia, and Indonesia unable to pay back foreign loans (which suddenly appeared more expensive following devaluation), the IMF took the lead role in organizing bailouts of creditors and investors.
IMF loans injected money into the Asian economies to enable them to pay back their foreign debts. The amounts at stake were not insignificant: U.S. banks' exposure in South Korea was estimated to total more than $10 billion. Bank America alone reportedly had more than $3 billion in outstanding loans to South Korean firms, and Citicorp more than $2 billion. The other major U.S. banks with outstanding loans to South Korea included J.P. Morgan, Bankers Trust, the Bank of New York and Chase Manhattan. [54] Instead of eating their losses, the banks which made bad loans in South Korea and elsewhere in Asia received the money owed them, in some cases over modestly extended repayment periods.
The IMF/ESF money goes in and goes out. The banks get their money, the countries contract new debts to the IMF and get stuck with the IMF austerity demands. These recessionary structural adjustment demands have had tragic consequences throughout Asia. In South Korea, the unemployment rate has skyrocketed from under 3 percent to approaching 10 percent. In Indonesia, economic contraction has eradicated the income growth of the last three decades, with poverty rates soaring from 11 to 40 percent. [55]
There is still more. Among the conditions imposed on the Asian countries by the IMF and Rubin are requirements that these countries open up their economies further to foreign investors. (These demands relate to foreign "direct investment" in factories, agriculture, and service operations ranging from tourism to banks, not just "portfolio" investment in stocks, bonds, and currency.) Treasury Secretary Robert Rubin specifically and successfully pressured South Korea to open up its financial sector.
As a result, the very U.S. banks that contributed to South Korea's crisis and received a U.S. taxpayer bailout now stand to buy up lucrative sectors of the South Korean economy. Similar demands have successfully been made in other troubled Asian countries. [56]
History repeated itself a few months later, this time as farce, in Russia. Despite a widespread understanding that Russia had fallen into the grips of an unmitigated criminal capitalism, foreign capital poured into the country at some points seeking to take advantage of interest rates that hit 100 percent. No one could have doubted the risk of lending to Russia. But when the inevitable collapse came, the IMF -- prodded by the Clinton Administration -- was there with a bailout package. In July, the IMF signed off on a $22 billion bailout. The IMF released $4 billion dollars into the country immediately. That money went to pay back domestic and foreign creditors, with the rest apparently stolen. It served absolutely no purpose but to subsidize the wealthy in and outside of Russia, all of whom had gambled with their investments in an effort to take advantage of the extraordinary interest offered. In August, Russia defaulted on its loans, and the IMF suspended the bailout.
Not only is the double subsidy to the Big Banks unjust, it helps perpetuate the very problem it is designed to remedy. When the IMF and the Treasury Department bailout the banks -- in effect providing free insurance -- it sends a message: "Don't worry about the downside of your international loans. As long as enough banks get in too deep, we'll rescue you at the end of the day." That encourages more reckless bank lending, since the banks can earn high interest on high risk loans without having to absorb losses. (Economists call this the "moral hazard" problem.) While consumers don't benefit from the higher bank profits, they frequently find themselves hit with higher charges when banks suffer losses from reckless lending that are not fully bailed out.
Working out a sensible system of international financial regulation, which avoids Wall Street bailouts and the unfairly punishing of debtor countries is a complicated matter. It is clear, however, that the IMF and the ESF have to be reined in. Indeed, even the Wall Street Journal and Wall Street conservatives such as George Schultz, William Simon and Walter Wriston have suggested the IMF's powers should be restricted or the Fund abolished altogether. [57]
The Republican majority on the International Financial Institution Advisory Commission (the Meltzer Commission, a Congressionally appointed panel) recommended a series of intriguing proposals to restrict IMF lending to avoid the moral hazard problem. [58] At minimum the IMF should be denied all new funds.
Second, Congressional authorization should be required for ESF expenditures of larger than $100 million. Representative Bernard Sanders has introduced legislation to require a Congressional vote prior to ESF expenditures over a specified amount.
NUCLEAR INSURANCE: THE PRICE-ANDERSON ACT
The nuclear industry may be the most subsidized in U.S. history. It is completely a product of U.S. government research and development. Having emerged from massive government investments, the nuclear industry has never cut its umbilical cord tie to the government. [59]
One critical, ongoing support for the industry is the Price-Anderson Indemnity Act, which limits the liability of the nuclear industry (both plant operators, and suppliers and vendors) in the event of a major nuclear accident. Under Price-Anderson, each utility is required to maintain $200 million in liability insurance per reactor. If claims following an accident exceed that amount, all other nuclear operators are required to pay up to $83.9 million for each reactor they operate. Under the terms of Price-Anderson, neither the owner of a unit which has a major accident nor the entire utility can be held liable for more than these sums. As of August 1998, this system capped insurance coverage for any accident at $9.43 billion. [60]
When the Price-Anderson Act was adopted in 1957, at the dawn of the commercial nuclear industry, the Act was intended to overcome reluctance to participate [in the transition to private nuclear industry] by the nascent industry worried by the possibility of catastrophic, uninsured claims resulting from a large nuclear accident." [61] Leaving aside for the moment the ecological and economic risks which should disqualify continuation of, let alone support for, the nuclear industry, assume that such a rationale was defensible at the time, as the government tried to promote development of an energy source which many believed would be safe, cheap, and abundant.
But watch how the rationalization perpetuates itself. "By 1965," the NRC reports, "when the first 10-year extension of the Act was being considered, a handful of nuclear power reactors was coming into operation, and the nuclear industry considered itself on the verge of expanding into large-scale nuclear power generation. Thus, the need for continued operation of the Price-Anderson system for the forthcoming 10 years was believed to be critical for the unrestricted development of nuclear power." [62]
A decade later, when another extension of the Act was being considered, the industry was more buoyantly optimistic than it ever had been or would be again. "With dozens of plants in operation or under construction and with hundreds more being contemplated to be in operation by the end of the century," the industry urged that the Act be extended rapidly so that "any uncertainty about extension would not disrupt nuclear power development," [63] says the NRC.
Now the industry is in decline. There have been no new orders for nuclear plants for the past 25 years, and aging plants are beginning to be shuttered. The original rationale for the Act is no longer plausible. But nothing has changed with respect to Price Anderson. Indeed, the NRC argues, "Given industry perception of the continuing need for Price-Anderson, and in view of the lack of new orders in plants, the situation is in some respects similar to what it was when Congress saw the need for enactment of the original Price-Anderson Act." [64]
(In one way, things are worse than they were in 1957: with nuclear plants closing due to aging, safety concerns, inefficiency, and license expiration, the Price-Anderson liability cap will progressively decline in future years. If the upper end of nuclear plant closing projections occurs, available insurance funds could shrink to $4.5 billion in 2013. [65])
The industry has gone through a full life cycle, but somehow it never outgrew the need for a federal insurance scheme and liability cap. The result has been a massive subsidy to nuclear power companies. Using the NRC's conservative numbers for the upper limit on a worst-case scenario accident and on the probability of such an accident occurring, Professors Jeffrey Dubin and Geoffrey Rothwell estimated the cumulative Price-Anderson subsidy to the nuclear industry through 1988 to be $111 billion in 1985 dollars. [66] This estimate is based on NRC data on the cost of worst-case accidents -- data which is conservative because it does not include health effects.
If, again, we leave aside the demerits of nuclear power, there could be justification for a federal scheme to promote risk sharing in a context which poses a (hypothetically) very small chance of an extremely large loss. (It should be emphasized, however, that this is exactly the situation for which the private insurance and reinsurance markets are designed.) But there is no justification for combining such a scheme with an overall liability cap.
The $9.4 billion liability is nowhere near sufficient to pay for the human health and property damages that could result from a nuclear meltdown. Nuclear Regulatory Commission studies have estimated costs in a worst-case scenario at more than $300 billion for a single catastrophe. [67]
The nuclear industry's real insurance program is not the $9.4 billion scheme of Price- Anderson, but the free insurance provided by the public. In the event of a catastrophic accident, after the $9.4 billion was spent, it is the federal government that would inevitably cover the costs -- with some costs probably absorbed by victims who have their injuries compounded by inadequate compensation.
Price-Anderson is a textbook example of the hybrid insurance-liability cap program that should be prohibited per se.
"Many nuclear suppliers express the view that without Price-Anderson coverage, they would not participate in the nuclear industry," reports the NRC. [68] If an industry which has benefited from massive government research and development and other subsidies for more than four decades, and which creates staggering, environmentally dangerous waste disposal problems and poses enormous risks to human health, cannot survive without government support, then it should not survive. The nuclear industry cannot meet the market insurance test and, with substitute energy sources available, it is not needed. The Price Anderson Act expires in 2002. If it is not repealed before then, it should not be renewed. If nuclear facilities close as a result, well, occasionally at least, corporate America should be subjected to the widely touted rigors of a free market.