Financial Moral Hazard

If we believe this Houdini act then we have only ourselves to blame.

How Many Bank Bailouts Can America Withstand?

The architects of the 2008 rescues pretend they’ve been vindicated.

Ten years after the financial crisis of 2008, the architects of the bailouts are still describing their taxpayer-backed rescues of certain financial firms as great products which were poorly marketed to the American people. The American people still aren’t buying.

A decade ago, federal regulators were in the midst of a series of unpredictable and inconsistent interventions in the financial marketplace. After rescuing creditors of the investment bank Bear Stearns and providing a partial rescue of its shareholders in March of 2008, the feds then shocked markets six months later by allowing the larger Lehman Brothers to declare bankruptcy. Then regulators immediately swerved again to take over insurer AIG and use it as a vehicle to rescue other financial firms.

Within days legislative drafts were circulating for a new bailout fund that would become the $700 billion Troubled Asset Relief Program. Throughout that fall of 2008 and into 2009, the government continued to roll out novel inventions to support particular players in the financial industry and beyond. Some firms received assistance on better terms than others and of course many firms, especially small ones outside of banking, received no help at all.

In the fall of 2008, Ben Bernanke chaired the Federal Reserve, Timothy Geithner ran the New York Fed and Hank Paulson served as U.S. Treasury secretary. Looking back now, the three bailout buddies have lately been congratulating themselves for doing a dirty but important job. They recently wrote in the New York Times:

Many of the actions necessary to stem the crisis, including the provision of loans and capital to financial institutions, were controversial and unpopular. To us, as to the public, the responses often seemed unjust, helping some of the very people and firms who had caused the damage. Those reactions are completely understandable, particularly since the economic pain from the panic was devastating for many.

The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.

The authors say that their actions saved the United States and the world from catastrophe, but of course this claim cannot be tested. We’ll never get to run the alternative experiment in which investors and executives all have to live with the consequences of their investments. But Stanford economist John Taylor has made the case that massive ad hoc federal interventions were among the causes of the conflagration. On the fifth anniversary of the crisis he noted that in 2008 markets deteriorated as the government was taking a more active role in the financial economy, which may have contributed to a sense of panic:

…the S&P 500 was higher on September 19—following a week of trading after the Lehman Brothers bankruptcy—than it was on September 12, the Friday before the bankruptcy. This indicates that some policy steps taken after September 19 worsened the problem… Note that the stock market crash started at the time TARP was being rolled out… When former Treasury Secretary Hank Paulson appeared on CNBC on the fifth anniversary of the Lehman Brothers failure, he said that the markets tanked, and he came to the rescue; effectively, the TARP saved us. Appearing on the same show minutes later, former Wells Fargo chairman and CEO Dick Kovacevich—observing the same facts in the same time—said that the TARP… made things worse.

CNBC reported at the time on its Kovacevich interview:

TARP caused the crisis to get “much greater,” he added.

“Shortly after TARP, the stock market fell by 40 percent,” he continued. “And the banking industry stocks fell by 80 percent. How can anyone say that TARP increased the confidence level of an industry, when its stock market valuation fell by 80 percent.”

Perhaps the argument can never be resolved. What is known but is conveniently left out of the Times op-ed is an acknowledgment of the role that regulators played in creating the crisis by encouraging financial firms to invest in mortgage debt, to operate with high leverage and to expect help in a crisis. The Times piece includes no mention of Mr. Bernanke and his Fed colleagues holding interest rates too low for too long, or the massive risks at Citigroup overseen by Mr. Geithner’s New York Fed, or the mortgage bets at AIG approved by the Office of Thrift Supervision at Mr. Paulson’s Treasury Department.

Foolish regulators creating bad incentives was nothing new, though Beltway blunders had rarely if ever occurred on such a scale. What was of course most shocking for many Americans in 2008 was observing so many of their tax dollars flowing into the coffers of large financial institutions. For months both the financial economy and the real economy suffered as Washington continued its ad hoc experiments favoring one type of firm or another.

In 2009 markets began to recover and, thanks in no small part to years of monetary expansion by the Federal Reserve, stock investors enjoyed a long boom. But when it comes to economic growth and wages for the average worker there was no such boom, just an era of discouraged Americans leaving the labor force. And by keeping interest rates near zero for years, the Fed punished savers and enabled an historic binge of government borrowing.

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That federal borrowing binge was also enabled by the rescue programs. The basic problem was that once Washington said yes to bailing out large financial houses, politicians could hardly say no to anyone else. It was no coincidence that just months after enacting the $700 billion TARP, lawmakers enacted an $800 billion stimulus plan. So began the era of trillion-dollar annual deficits. Since the fall of 2008, federal debt has more than doubled and now stands at more than $21 trillion.

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The expansion of government also included record-setting levels of regulation, which limited economic growth. A financial economy heavily distorted by federal housing policy was cast as the free market that failed, and decision-making affecting every industry was further concentrated in Washington.

Messrs. Bernanke, Geithner and Paulson make the case that they saved the financial system but failed to sell the public on the value of their interventions. It’s a sale that can never be made. Even if the bailouts hadn’t led to an era of diminished opportunity and skyrocketing federal debt, Americans would have resisted the idea that our system requires occasional instant welfare programs for wealthy recipients chosen by un-elected wise men.

The bailout buddies are now urging the creation of more authorities for regulators to stage future bailouts. The Trump administration should do the opposite, so that bank investors finally understand they will get no help in a crisis.

This column isn’t sure how many bailouts of financiers the American political system can withstand but is certain that such efforts will never be welcomed by non-financiers.

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Bank Bailout 3.0

I’d have to agree with this. As we’ve said all along, saving the banking system was necessary, saving the bankers was not. Now we’re set up for the next bailout of the financial elite. What a great casino this is: heads they win, tails we lose.

The bank bailout of 2008 was unnecessary. Fed Chairman Ben Bernanke scared Congress into it

By Dean Baker

This week marked 10 years since the harrowing descent into the financial crisis — when the huge investment bank Lehman Bros. went into bankruptcy, with the country’s largest insurer, AIG, about to follow. No one was sure which financial institution might be next to fall.

 

The banking system started to freeze up. Banks typically extend short-term credit to one another for a few hundredths of a percentage point more than the cost of borrowing from the federal government. This gap exploded to 4 or 5 percentage points after Lehman collapsed. Federal Reserve Chair Ben Bernanke — along with Treasury Secretary Henry Paulson and Federal Reserve Bank of New York President Timothy Geithner — rushed to Congress to get $700 billion to bail out the banks. “If we don’t do this today we won’t have an economy on Monday,” is the line famously attributed to Bernanke.

The trio argued to lawmakers that without the bailout, the United States faced a catastrophic collapse of the financial system and a second Great Depression.

Neither part of that story was true.

Still, news reports on the crisis raised the prospect of empty ATMs and checks uncashed. There were stories in major media outlets about the bank runs of 1929.

No such scenario was in the cards in 2008.

Unlike 1929, we have the Federal Deposit Insurance Corporation. The FDIC was created precisely to prevent the sort of bank runs that were common during the Great Depression and earlier financial panics. The FDIC is very good at taking over a failed bank to ensure that checks are honored and ATMs keep working. In fact, the FDIC took over several major banks and many minor ones during the Great Recession. Business carried on as normal and most customers — unless they were following the news closely — remained unaware.

 

The prospect of Great Depression-style joblessness and bread lines was just a scare tactic used by Bernanke, Paulson and other proponents of the bailout.

Had bank collapses been more widespread, stretching the FDIC staff thin, it is certainly possible that there would be glitches. This could have led to some inability to access bank accounts immediately, but that inconvenience would most likely have lasted days, not weeks or months.

 

Following the collapse of Lehman Bros., however, the trio promoting the bank bailout pointed to a specific panic point: the commercial paper market. Commercial paper is short-term debt (30 to 90 days) that companies typically use to finance their operations. Without being able to borrow in this market even healthy companies not directly affected by the financial crisis such as Boeing or Verizon would have been unable to meet their payroll or pay their suppliers. That really would have been a disaster for the economy.

However, a $700-billion bank bailout wasn’t required to restore the commercial paper market. The country discovered this fact the weekend after Congress approved the bailout when the Fed announced a special lending facility to buy commercial paper ensuring the availability of credit for businesses.

 

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Without the bailout, yes, bank failures would have been more widespread and the initial downturn in 2008 and 2009 would have been worse. We were losing 700,000 jobs a month following the collapse of Lehman. Perhaps this would have been 800,000 or 900,000 a month. That is a very bad story, but still not the makings of an unavoidable depression with a decade of double-digit unemployment.

 

The Great Depression ended because of the massive government spending needed to fight World War II. But we don’t need a war to spend money. If the private sector is not creating enough demand for workers, the government can fill the gap by spending money on infrastructure, education, healthcare, childcare or many other needs.

There is no plausible story where a series of bank collapses in 2008-2009 would have prevented the federal government from spending the money needed to restore full employment. The prospect of Great Depression-style joblessness and bread lines was just a scare tactic used by Bernanke, Paulson and other proponents of the bailout to get the political support needed to save the Wall Street banks.

 

This kept the bloated financial structure that had developed over the last three decades in place. And it allowed the bankers who got rich off of the risky financial practices that led to the crisis to avoid the consequences of their actions.

 

While an orderly transition would have been best, if the market had been allowed to work its magic, we could have quickly eliminated bloat in the financial sector and sent the unscrupulous Wall Street banks into the dustbin of history. Instead, millions of Americans still suffered through the Great Recession, losing homes and jobs, and the big banks are bigger than ever. Saving the banks became the priority of the president and Congress. Saving people’s homes and jobs mattered much less or not at all.

 

Dean Baker is senior economist at the Center for Economic and Policy Research and the author of “Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer.”

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