Free Lunch: The legacy of America's bailouts

Δημοσιεύθηκε: 13 Μαΐου 2015 - 11:52

Remembering 2008

Battles are again flaring in the US Congress over how best to regulate America's financial sector. Various amendments and refinements of the Dodd-Frank financial regulatory reforms are being proposed. Republicans want to exempt more banks from the more onerous regulations that come with being designated too big to fail. Meanwhile that bipartisan duo of Wall Street scourges, senators Elizabeth Warren and David Vitter, want to constrain crisis lending by the Federal Reserve to prevent bailouts at taxpayer expense.

It is a good time to recall the original impetus for regulatory reform: the multiple and enormous bailouts of companies considered too big to fail from 2008 onwards. The latest issue of the Journal of Economic Perspectives is devoted to a symposium on the bailouts. In a number of articles, experts - sometimes people who were very close to the policy action at the time - lay out the facts behind the calls for government rescues, what form they took and how successful they were. Reading them is a chilling reminder of just how colossal the bailouts were and how central to the US economy were the corporate giants grovelling at the Fed's and the US Treasury's feet. The articles cover the "bazookas" deployed to help: the Detroit auto manufacturers; the mortgage insurers Fannie Mae and Freddie Mac; the banks rescued by the Troubled Assets Relief Program; and the gargantuan AIG insurance company. A final article looks at the legal complications surrounding the issue.

The fact that many are written by those who influenced the decisions of course gives a bias to their discussion. But there is a lot to learn, or re-learn what we may have forgotten, in these articles. For example: that the US government came out overall in the black from its interventions, though this profit came at enormous risk and was far from guaranteed at the outset.

One striking impression from reading the articles together is just how pressing the need to bail out the companies - as opposed to letting them fail - was perceived to be at the time. Even the article on the Detroit bailout (that would be the carmakers, not City Hall) seems to make too little of the difference between the $20bn support given by the Bush administration and the tens of billions added by the Obama administration. The difference, of course, was that Obama let GM and Chrysler go through the wringer of bankruptcy - a difference that makes the Bush administration the relative socialist and the Obama administration the capitalist in this story.

No similar balance sheet restructuring, with losses imposed on creditors, was imposed in any of the other rescues. It is quite clear that the non-bank rescues - especially Fannie Mae and Freddie Mac - were designed with the banking sector (including investment banks) in mind. There was a - generally accepted - sense that a liquidity and credit crunch for the real economy must be avoided at all costs, and a - generally unquestioned, at least in these articles - sense that this meant not allowing any of the big banks, or other institutions they depended on, to fail in a way that would force some of their creditors to share in their losses. Given how much the auto rescue achieved by doing precisely that, one would have wished for a deeper questioning of whether the fear of creditor writedowns at the time, fanned by the fallout from the Lehman Brothers bankruptcy, was exaggerated.

There are little hints at such a questioning in some of the papers. Charles Calomiris and Urooj Khan, in their autopsy of Tarp, mention that the Lehman damage may have reflected "changing perceptions of the scale of loss associated with exposures to subprime and Alt-A mortgages" rather than losses on exposures to Lehman itself. If so, Lehman may have triggered a huge revaluation that would eventually have happened anyway. They add: "Lehman's derivatives were liquidated in an orderly fashion, and no major intermediary actually failed as the result of interconnections with Lehman. From that perspective, Secretary Paulson's view that the economy was teetering at the edge of Armageddon may have been a gross exaggeration."

In his discussion of the legal constraints, Philip Swagel mentions that Luigi Zingales proposed as early as October 2008 that Congress should legislate for a pre-packaged bankruptcy restructuring scheme for undercapitalised banks. This would avoid the chaos of ordinary bankruptcy and also ensure that recapitalisation bills did not fall on taxpayers. It would not, of course, ensure that banks' creditors were made whole. This choice was barely questioned then and has remained insufficiently questioned since. Until it is even better illuminated, expect legislative fights over too-big-to-fail to continue.