Bailouts Forever

April 20th, 2010 at 12:20 am | 27 Comments |

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Senate Minority Leader Mitch McConnell has accused the Obama administration, Sen. Chris Dodd, and, by implication, most other Democrats of plotting for permanent bailouts of the financial system.  He’s right. But Democrats can rightly point out that McConnell, every other member of Congress, and, indeed, just about every American citizen, want the same thing.

A bailout, of course, is what happens when the government keeps an explicit or implicit promise to stop an institution from failing or a financial instrument from loosing its value.  And these guarantees are very common: many widely owned products—savings accounts, certificates of deposit, pensions, retail brokerage accounts, and admitted market homeowners insurance—all have attached guarantees.  In many cases, people even use different names for guaranteed and non-guaranteed products: a CD without a government guarantee is called a bond, property insurance without a guarantee is called an excess and surplus lines policy. One expects that these guarantees will eventually be needed: there wouldn’t be a point in offering them if they weren’t. So, as long as the government guarantees any financial instrument, in short, it will engage in bailouts. The only true “no more bailouts” policy would involve abolishing the Federal Deposit Insurance Corporation, the Securities Investor Protection Corporation, more than 50 state insurance guarantee funds, the Pension Benefit Guarantee Corporation, the National Credit Union Share Insurance Fund and at least a half dozen other entities.

Even if this were a good idea, it probably wouldn’t get a single vote in Congress.  Among other things, abolishing all public-sector guarantees would upend the business model of nearly every financial services firm in the country, lead some families to financial ruin, and end the sale of certain products. In short, while proposing an end to all guarantees may make good fodder for dorm-room bull sessions, it will never go anywhere.

Any practical look at policy towards bailouts should focus on how to limit them.

This means the government should get out of some guarantee businesses altogether, avoid entering new ones, and enforce regulations to minimize the need for those guarantees that can’t go away.

If the private market handles a type of product without problems, then the government has no business guaranteeing it. For example, the mortgage backed securities sold by Fannie Mae and Freddie Mac should never have had an implicit government guarantee even though providing it probably lowered mortgage rates. The private market is fully capable of selling mortgage-backed securities and, if the government really wants to promote homeownership, backing massive financial instruments was a poor way to do it.

A desire to minimize bailouts also means that proposals floating around to create a “resolution authority” for big financial firms, get the federal government into the reinsurance business to reduce the cost of beach home property insurance (yes, really), and provide additional security for investors who fall victim to fraud deserve enormous skepticism. They may address real problems but they also increase the chances of future bailouts.

Instead, the Congress should focus on tightening the core duties of regulators that can prevent bailouts. So long as the FDIC exists, no bank should have a reason to complain about audits to make sure it has enough reserves. Insurers shouldn’t complain when states scrutinize their books to make sure they actually can pay claims. In some cases, these regulations may be “bad for business” or “anti-innovation.” This is fine. A firm that’s eligible for a bailout shouldn’t have quite the same opportunities as one that isn’t.

Whatever happens, future bailouts are inevitable; Congress should work to minimize the need for them.

Recent Posts by Eli Lehrer



27 Comments so far ↓

  • abejero | from the Big Apple to the banks of the Mekong

    [...] Frum explains bailouts: Senate Minority Leader Mitch McConnell has accused the Obama administration, Sen. Chris Dodd, and, [...]

  • msmilack

    McConnell is representing exactly the opposite of what is true.

  • TerryF98

    Eli perpetuates McConnells lie. Remeber a lie repeated often enough becomes a kind of truth. Truthiness.

    There is no taxpayer bailouts in this bill. The fund which is to be garnered from the financial institutions themselves is to be used to WIND DOWN the failed bank. Repeat WIND IT DOWN. Not support it.

    Why does Eli lie and mis represent this? Because maybe he has a vested interest in the statue quo.

    Why did McConnell meet last week with 25 leading bankers? To agree a deal where the bankers give the GOP shedloads of cash in exchange for blocking the bill. A bribe in other words.

    Sto lying Eli, It’s so plain to see what you are trying to do here.

  • crzymke

    This article seems to consist of one or two demonstrably false statements surrounded by a bunch of platitudes. Considering the fund in question is too small to bailout any seriously large bank, is funded by the banks themselves, and explicitly intended for the dismantling of a failed bank – I’m not sure what the poster is basing his assertions on.

    I don’t claim any special legislative knowledge and welcome an alternative view on a complex provision, but I began reading FrumForum recently as a source for well-reasoned conservative arguments. This is a talking point. It doesn’t even seem to be in opposition of the legislation, rather framed to confuse the issue.

  • Rob_654

    Obviously is a huge firm gets into trouble we will bail them out. These firms spend a ton of money on politicians and they will get what they want – and besides – all of the people screaming about bailing out the companies would be screaming about the outcome to the economy if all of those huge firms had been allowed to fail – they would be blaming Obama for that too…

  • sinz54

    TerryF98: The fund which is to be garnered from the financial institutions themselves is to be used to WIND DOWN the failed bank. Repeat WIND IT DOWN.
    Politico.com reported that the fund is going to be removed from the final version of the bill.

    As a result, the bill will no longer have ANY funded mechanism for wind-down–and a future Administration will once again have to go to Congress for another TARP.

  • rbottoms

    As a result, the bill will no longer have ANY funded mechanism for wind-down–and a future Administration will once again have to go to Congress for another TARP.

    Obama’s fault of course.

  • Oskar

    Nationalize Wall Street.

  • balconesfault

    It seems to me that it would be a brilliant move to guarantee some level of security for financial institutions up to a certain size through bureaucratic processes, and then require a more public/political process for bailing out larger institutions.

    The resulting uncertainty for institutions above the threshold would ensure that capital flows towards the more manageable institutions, and would provide a disincentive towards the mergers and acquisitions that create those “too big to fail” behemoths that risk bringing down the economy.

  • rectonoverso

    “Whatever happens, future bailouts are inevitable; Congress should work to minimize the need for them.”

    Which is exactly what they are doing, in particular impose more transparency in the derivatives market and legislate CDSs as insurances

  • DFL

    Bailouts forever? At least until debt and government entitlements cause the whole system to collapse. How much longer can the USA surivive trillion dolar deficits? What happens when Wall Street needs a bail out when the treasury is bankrupt?

  • sinz54

    DFL: I’m not sure about the mechanism “balconesfault” is suggesting,
    but something must be done to stop markets and corporations from becoming “too big to fail” in the first place.

    And that includes a procedure for determining whether or not a given organization really is “too big to fail”.

    If the financial markets had collapsed, the U.S. would have been in serious trouble. They were too big to fail.

    But I have never understood why we had to bail out General Motors. Does anyone really think that the bankruptcy of GM, which had been losing workers and market share for years already, would have destroyed the U.S. economy? No. It was a blatant payoff by Obama to the UAW for having supported his candidacy.

    A conservative administration would have worked with GM to orchestrate its sale to Honda.

  • blowtorch_bob

    Why not just bring back the Glass-Stegell Act? I think you will find this will put an end to all the monkey business in the banking system.

  • balconesfault

    But I have never understood why we had to bail out General Motors. Does anyone really think that the bankruptcy of GM, which had been losing workers and market share for years already, would have destroyed the U.S. economy?

    At a time that the US economy was already reeling from massive layoffs throughout industry, and when the unemployment rate was growing by a percentage point a month, the loss of jobs not only at GM and Chrysler but up and down their supply and distribution chains would have very possibly sent the US economy into depression.

    Yes, I do believe this.

  • COProgressive

    Eli wrote;
    “A bailout, of course, is what happens when the government keeps an explicit or implicit promise to stop an institution from failing or a financial instrument from loosing its value.”

    Well, first, Eli this was a piece of blather based on an untruth from the start.

    Second, the proposed FinReg Bill doesn’t provide for future “bailouts”. It creates a industry funded source of money to pay funereal expences for the institutions that have outlived their usefulness or who have committed financial suicide. What we need is more Lehman Bros. Others, like Goldman, may be too big to fail, but they are not too big to be sliced and diced and peared down. Let’s get the financial markets competive again instead of having three or four 800 pound gorillas making the rules and calling the shots.

    Next, we need to get the banks out of the casinos. Let the banks care for their customers deposits and let the investors gamble in the casinos.

    What you have done is to take Frank Luntz’s talking points and attempted to create “facts” around them.

    The Goldman Sachs indictment is just the first of future investigations into the seedy world of synthetic deriviatives where some have received huge fortune payouts betting on the failures of others paid by the American taxpayer.

    The “Gaming” of OUR economic system must stop.

  • COProgressive

    sinz54 wrote @ 12:14;
    “Does anyone really think that the bankruptcy of GM, which had been losing workers and market share for years already, would have destroyed the U.S. economy? No. It was a blatant payoff by Obama to the UAW for having supported his candidacy.”

    There’s a big difference between the bankrupcy of GM and the bailout of AIG and the financial markets. The difference being with GM, closing their doors would have put not only GM workers, American working men and woman, on the streets as well as the “Trickle Down” of those layoffs to the subcontractors and their employees and the contined “Trickle Down” to the Main Street Mom & Pop stores as well.

    While the with the financial market bailout, AIG in particular, the bailout only gave American Taxpayer dollars, you know, those folks that get up every morning and shower and dress and head out to the plant to MAKE THINGS, to a corporation that oversold insurance on papers (bonds) purchased by investors, yes, some of them pension funds, but most people who get up every morning and pick up the Wall Street Journal and read it as they log on to their Goldman or Smith Barney account to see how much they made in overseas trading while they slept.

    The AIG bailout was especially grievous because we, the US taxpayer, bailed out a company that was playing fast and loose with others in the financial industry by selling insurance on bonds that were about to explode and not having the money to cover the bets made. If anything, we should have cut a deal and paid for AIG’s excesses for pennies on the dollar rather than making all the betters whole.

    But the story on the AIG bailout and how the deal was cut is the subject of another of my rants.

  • PETERSON: Understanding Financial Reform | THE POLITICIZER

    [...] ending the possibility of any future government bailouts. FrumForum’s Eli Lehrer offers some insight: A bailout, of course, is what happens when the government keeps an explicit or implicit promise to [...]

  • SFTor1

    What stands in the way of a simple eBay for investments? Wall Street has become toxic, dangerous, and irrelevant, populated by thieves and leeches.

    Let’s shut them down, before they succeed in doing the same to all of us.

    And COProgressive is right. The GM bailout was the only part of TARP that went to Main Street, of sorts.

  • sdspringy

    The bursting housing bubble, the resulting loss in value of mortgage backed securities, the too big to fail financial institutions, all problems the new regulations will NOT fix.

    Will the new regulation require separation of function?
    Will the new regulation remove Fannie and Freddie from the speculative mortgage market?
    Will Goldman Sach come out smelling like a rose, you bet they will, Thank you Dodd/Obama.

    Many companies continue to operate while in bankruptcy. Ever fly the friendly skies, in the last 20 years, you flew on a bankrupt airline.
    This GM bailout was a ruse to prevent GM from going bankrupt and being able then to renegotiate all their labor contracts.
    That’s what happens during a bankruptcy, renegotiation, the UAW would not been happy with the new contracts.
    It was a payoff to the union.
    It used taxpayer dollars not to support jobs, they still would have been working while GM came out of bankruptcy, but to support Union contracts.

  • balconesfault

    The bursting housing bubble, the resulting loss in value of mortgage backed securities, the too big to fail financial institutions, all problems the new regulations will NOT fix.

    Actually, they will. Because the heavy duty marketing of adjusted rate mortgages were fueled in no small part by the demand for those mortgages as more fodder for the derivatives market. So big bonuses were being paid to loan agents to bring in more mortgages … which incentivized them to skip credit checks, accept ridiculous assumptions about future income potential, and sell those taking out the loans on the idea that housing prices would ALWAYS go up, so they could refinance before the balloon ever burst on their rate.

    Yes, those loan agents were acting badly. But if the free market teaches us anything, it’s that there will always be people willing to act badly if the compensation is high enough. And the need for more mortgages that could be sliced, diced, and leveraged is the reason the compensation was high enough.

  • sdspringy

    From the Huffington Post:
    http://www.huffingtonpost.com/2010/04/20/exclusive-dem-insiders-ec_n_544187.html

    I know how much you personnally believe in Hope & Change Balcon, unfortunately not even those on your side of the fence think any reform will be accomplished.

  • sinz54

    COProgressive: but most people who get up every morning and pick up the Wall Street Journal and read it as they log on to their Goldman or Smith Barney account to see how much they made in overseas trading while they slept.
    I know you don’t care what happens to such folks.

    But what about the staff in those companies, as in all companies? Secretaries? Clerks? Telephone representatives? Janitors? The technicians who manage the computers and the electronic networks? You don’t care about their jobs either?

    AIG employs 100,000 people. They’re not 100,000 stock brokers. Most of them have average ordinary support jobs to support the brokers and financiers.

    And General Motors, if it went bankrupt, wouldn’t go to waste. I said that what the Government should have done is engineer a takeover of GM by Honda or maybe Daimler or some other big corporation. The factories would continue–under new management, that’s all.

  • sinz54

    sdspringy: Many companies continue to operate while in bankruptcy. Ever fly the friendly skies, in the last 20 years, you flew on a bankrupt airline.
    Not a good analogy.

    When you fly on an airplane, it’s a one-off. You pay for the flight, you fly, and you’re out of there.

    But surveys of car-buying consumers showed they were worried about whether a bankrupt company (like GM) could continue to honor its vehicle warranties; and whether its dealers could continue to offer attractive financing. It wasn’t the failings of the factories that destroyed GM. It was finance: GMAC and the pension funds.

    That’s why I would fly on a bankrupt airline, but I would never buy a car from a bankrupt company. Because buying a car is a contract that involves commitments from the company even after I drive the car off the lot. And in bankruptcy, all commitments are up for renegotiation.

  • TerryF98

    Regarding GM,

    Some news..

    “General Motors Co. Chief Executive Officer Ed Whitacre said GM has repaid $5.8 billion in loans to the U.S. and Canada in an opinion piece published on the Wall Street Journal’s Web site.

    “We’re paying back — in full, with interest, years ahead of schedule — loans made to fund the new GM,” Whitacre wrote.”

    And.

    The U.S. Treasury converted another 43-billion dollars of GM loans to stock.

    But just how much of that money taxpayers will get back depends on the value of GM’s stock.

    Wolkonowitz says taxpayers could recoup virtually all their investment if the government waits until 2013 or 2014 to sell its stock.

    But the Obama administration says it wants to divest the stock as soon as possible.”

  • TerryF98

    Conventional wisdom confirmed. Conservatives create financial meltdowns. Liberals clean them up.

    Financial cycles of boom and bust are as old as finance itself—a fact that has led some observers to infer that human nature may be a fundamental cause of financial cycles. But “politics” also influences financial cycles by way of government policies and regulations. I argue that policies and regulations vary predictably with the partisan character of the government, creating a partisan-policy financial cycle in which conservative, pro-market governments preside over financial booms while left-wing governments are elected to office after crashes. My sample consists of all bank-centered financial crises to hit advanced countries since World War II, including the current “Subprime” crises—a total of 27 cases. I find that governments in power prior to major financial crises are more likely than the average OECD country to be right-of-center in political orientation. I also find that these governments are more likely than the OECD average to be associated with policies that predict crises: large fiscal and current account deficits, heavy borrowing from abroad, and lax bank regulation. However, once a financial major crisis occurs, the causal arrow flips and government partisanship becomes a consequence of crises. I find that the electorate moves to the left after a major financial crisis, and this leftward shift is associated with changes in government partisanship in that direction

    more at

    http://www.themonkeycage.org/2010/04/the_right_creates_financial_cr.html

  • Diomedes

    Unfortunately, the precedent has already been set and the moral hazard ratified.

    Face the facts: Republican or Democrats, whoever may be in charge, will ALWAYS placate to Wall Street. They are now joined at the hip forever and for all eternity.

    Unless somebody finds a way to resurrect Harry Truman, the country will be forever on its knees while Wall Street and its ilk find ever more inventive and unethical ways of boosting their net worth at the expense of the middle class.

    Oligarchy, here we come….

  • tdaxp » Blog Archive » The Bad and the Good

    [...] The Obama Administration and Goldman Sachs are in a kabuki dance with the intent on institutionalizing the bailout system. [...]