Bailout Nation

The United States Government’s bailout of the financial sector is approaching breathtaking proportions. There are so many pronouncements and announcements of this monetary stimulus and that loan of this preferred equity stake and that interest rate cut that I can’t keep up with the news flow. Meanwhile, on Main Street many a homeowner will wait for her bailout in vain. Welcome to Bailout Nation.

This whole mess started with the assistance that the Federal Reserve gave to JPMorgan Chase in taking over Bear Stearns. The failure of Bear came as a bit of a surprise and the Fed was loathe to let the investment bank collapse completely for fear of systemic risk. These bailouts continued with the conservatorship of Fannie Mae and Freddie Mac, which effectively nationalized both government-sponsored enterprises.

However, Paulson and company got cold feet after this mammoth deal. After all, the Bush administration was supposed to be full of laissez-faire, market-oriented businessmen. Subsequently, they decided to let Lehman Brothers fail and the whole house of cards that is our global financial system collapsed.

I don’t need to go into a point-by-point recount of what has happened but I do want to use recent events as a demonstration of where this has led.

Take Fannie and Freddie for example. Jake at EconomPic Data has a very nice article on this today. He shows that these organizations, likely to cost taxpayers many hundreds of billions of dollars, have lost more money in 2008 so far than they gained in the entire previous business cycle. I definitely suggest you read this article, “Fannie: Going Concern, but I am Getting Concerned” because it will enlighten you as to the magnitude of the anticipated bailout.

Then there is AIG. After Lehman Brothers went belly up, AIG’s share prices collapsed and they looked likely to fail. However, the Federal Reserve panicked as the Lehman failure demonstrated the risk of allowing financial companies to fail. And AIG was a systemically important institution. So, the Fed tried to put the company on a leash by using very severe lending terms and making the government the de-facto owner of the institution. The problem is that AIG needs more money, much more. The rescue has grown to $150 billion and the government has ponied up another $40 billion in preferred shares while relaxing the loan terms significantly. That is not a very tight leash AIG is on.

Next, we come to American Express. Apparently, the US Government feels that American Express needs to get on the gravy train as well given that they just granted the company authorization to become a bank holding company. Bank holding companies can lend at low rates from the Federal Reserve, offering up dodgy collateral like Asset-backed securities in turn. That is why all of the investment banks have become bank holding companies and that is also why the Federal Reserve has been sued by Bloomberg News to find out just what kind of collateral these companies are using.

And, then finally, there are the automakers. Even though this is a financial crisis, somehow the automakers weasled their way into discussions on Capitol Hill with Pelosi and the Gang about a bailout. Now, Rahm Emanuel, who is going to be the new President’s chief of staff has said he favors helping the automakers. This suggests that the bailouts for the financial services companies may now move to bailing out even more companies.

There are many problems with all of this, the first being that you and I are not getting bailed out. It strikes one as a clear signal that special interest groups like the Big Three Automakers and the Financial Services industry are getting special treatment while ordinary citizens are left to fend for themselves. Yes, there are many jobs here at risk. And, yes the auto industry is strategically important in America. But, there are bankruptcy laws in this country and I reckon GM, Ford and Chrysler could avail themselves of those laws just as the airline industry has done.

America is quickly becoming a Bailout Nation. And given the lack of savings in this country, I fear that making good on all of the bailout promises our Federal Government has made points in only one direction: printing money.

Originally published on November 11, 2008 at Credit Write Downs and reproduced here with the author’s permission.

7 Responses to "Bailout Nation"

  1. villager   November 12, 2008 at 10:12 am

    Lessons learned from the current season of bailouts;1. Too big to fail means too big to bail.2. If authorities don’t understand what (the magnitude and unintended consequences) they are bailing, don’t bail.3. Bailing to survive for another day (eg. carmakers) is the wrong principle to follow. Only bail if credible analysis shows that the financial situation can actually be reversed. In the case of carmakers, they are dead unless the government wants to be the owner.4. The notion of bailing in order to ease the downside adjustment needs revisiting. The argument always assumes that the cost of not bailing-out is higher than the cost of the adjustment. In my opinion, this has yet to be proved.

  2. TheEdge   November 12, 2008 at 10:31 am

    (musical note) Inflation, flation what’s your function? Making people poor and eliminating the “middle class”. Inflation, flation what’s your function? Inciting revolution and bringing down a country. Inflation, flation who caused you? Greed by big bonus executives who could not “self regulate” and government policy fueld by Mr. Greenspan (“Oops!”). Inflation, flation what do we do now? Get religion and lower your living standards. [Alaska for sale…includes fledgling presidential leader.]

  3. Banana Republic   November 12, 2008 at 11:37 am

    funny thing too is now the financial industry is consolidating, creating more “Too big to fail” companies. I don’t blame them, it is perfectly rational as you know the government will be more likely to bail you out, if and when you need it.

  4. Anonymous   November 12, 2008 at 3:39 pm

    BAILOUTS ARE COMPLEX BEASTSHere is a workable plan with common sense for the U.S. Auto Industry - not leave it to the likes of Paulson or Congress to come up with a creative plan or consider taxpayers’ interests.It is this, or bankruptcy. The American Auto industry should be saved but under new conditions.There is much creative talent hidden inside the U.S. Big 3 that has been smothered by mismanagement and the UAW.

  5. Guest   November 12, 2008 at 4:20 pm

    I don’t see why the author is complaining. Everyone agrees financial institutions should be saved, even the author admits “they decided to let Lehman Brothers fail and the whole house of cards that is our global financial system collapsed”. That must not happen again. Besides, Fannie Mae and Freddie Mac are semi-government institutions, their failure will call into question the credibility of the government.As to automakers, what can you do when you are elected on union ticket? It is pay back time.

    • villager   November 13, 2008 at 8:06 am

      I think that the failure to support Lehman illustrates that the bailout authorities did not know what they were doing other than they were acting with the sole desire to protect Wall St. interests and that for me is not sufficient cause for bailout. The authorities had no conception of how badly the overall economy was affected by the toxic assets and inflated housing prices regardless of Roubini’s and others efforts at enlightenment. On the other hand, if they did, they did not care. When the bailout could have been used effectively, it was not. The connection of Lehman to the commercial paper market was not deemed important. It was not a priority of Wall Street. That to me is the failure of the bailout plan. Even today, there is continued question about what is the “plan”. The authorities continue to appear befuddled. In my opinion, no bailout is better than the errant, hapless nature of the current approach. The whole notion of “triage” that Nouriel Roubini advises as being necessary appears to be completely overlooked or ignored. How can correction occur in the economy without failure of some business enterprises? Moreover, the taxpayer interests are not being protected by the authorities. There is sufficient evidence to illustrate that the taxpayer is being given little or no consideration for the enormous amount of cost that is being created for the taxpayer’s supposed benefit.

  6. Deborah   November 12, 2008 at 6:55 pm

    No BailoutBankruptcy is not the end of the world. Even after the Chyrsler bailout 1/3 of the employees lost their jobs. Bankruptcy might be the only way to cleanse and purge these companies. They might even come back stronger, by producing the cars they should have been manufacturing 10 years ago. Remember Bush gave tax breaks to SUVs.If they give AIG any more money I think I will scream!Why am I paying for the rich peoples mistake. Take my share of the bailout and help a young family keep their house.