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Be (Very) Wary of Government Loan Guarantees

In a letter to the editor in today’s Wall Street Journal, United Airlines Chairman & CEO, Glenn Tilton, pleads his case for taxpayer-backing of loans to his company. He confidently asserts: “we will be able to repay these loans.”

Be wary.

A crucial and inescapable fact about government loan guarantees is that they substitute the judgment of politicians for the judgment of private investors.

Think about it. Capital markets are in the business of supplying liquidity to cash-strapped but efficient firms. That’s what private investors do. They specialize in assessing firms’ promise or lack of promise. Private investors are experienced at this task. Private investors are unlikely to be biased by political tensions. Private investors have their own or their clients’ money directly at stake. If they invest wisely, they personally profit handsomely; if they invest poorly, they personally lose.

And there are countless such investors worldwide – venture capitalists, banks, investment funds, filthy rich oil sheiks. If a company can’t persuade Bank of America to lend it funds, it can take its case to Credit Suisse First Boston. If it fails there it can ask Deutsche Bank…. and on and on through an impressive array of possible lenders and investors.

If a private firm cannot persuade the many private investors around the world to lend it all the money it claims to need to achieve its alleged promise, then it is very unlikely that this firm is worthy of the loan. It’s possible, of course, that each and every private investor mistakenly underestimates the firm’s prospects, and that politicians, in contrast, get the assessment right. But surely the odds are overwhelming that if private investors are unwilling to come forward, without being subsidized, with a sufficient amount of liquidity for the firm, then this firm is unlikely to be a wise investment.