Sheila Bair, who ran the FDIC during the crisis, argues against further bank bailouts. She earned great respect. One thing, which she doesn’t mention, is that she refused to let Geithner use the FDIC trust fund to bear the lower tail risk while leaving the upper tail profits to investors in Public Private Investment Partnerships. She insisted on having a veto on non-recourse FDIC loans used to purchase newly made pools of iffy mortgages. As a result, the prediction by Paul Krugman and Joe Stiglitz that the program was a scam turned out to be incorrect, while my prediction turned out to be correct.
Nonetheless I partially disagree with her firm op-ed. Oddly, the point is that it completely neglects the accomplishment of people like Sheila Bair (there may be only one of them). In her column she doesn’t mention the fact that the US Federal Government made a huge profit bailing out the financial system. The careless reader might imagine that the bailout consisted of grants and that the national debt was increased by the amount disbursed not reduced.
This isn’t key to her conclusion that such generous bailouts should be forbidden and that the Dodd-Frank act which requires that future interventions be more painful for bankers should be preserved. Her valid point is that the crisis caused huge losses, even though the bailout added less than nothing to those losses. She argues that planning future bailouts with profit for the US government but not enough pain for the bankers would create moral hazard. I absolutely agree.
But it is also a fact that the US government made huge profits (I think the hugest in world history). The moral hazard argument is valid and can stand totally aside from the insinuation that the bailouts cost taxpayers anything.
I think this is important, because since public onwnership of risky assets bought at higher than market clearing prices to save the financial system was profitable by accident, we must know there is a gigantic inefficiency. I think the reasonable response is to sell bonds and buy risky assets for market prices. That means that the profitability of the bailout is strong evidence that there should be partial public ownership of the means of production.
This was noted by John Quiggin decades ago (arguing against privatizing state owned firms in Australia). It has been argued by Miles Kimball for years. A little bird told me that Olivier Blanchard talked about it over lunch with Brad DeLong recently.
I think it is an important part of the lesson of 2008 (I admit I have been advocating it since 2005).
Shouldn’t “hugest” be “yugest?” Enough Sunday morning humor.
“the insinuation that the bailouts cost taxpayers anything”
If the insinuation is taxpayers were paid back in full through the profits gained from these interventions to save depository banks and the newly turned banks (which are still banks today) and everything was settled and back to a norm, I have a problem with such an assumption. Newly made Wall Street banks and depository banks did pay back the Fed loans with interest; however, Main Street paid the price in lost jobs due to the near collapse of Wall Street investment firms and depository banks from gambling.
Most recently, the Dems and Repubs over the last two years decided the level of close supervision could be lifted for banks with assets greater than $50 billion to a limit of $250 billion. This included some of the biggest offenders during the 2007/8 crash. This is troubling to me as we start to deregulate once again.
Including myself, many of us were shown the door as the economy collapsed into a severe recessional state. It forced me to leave Michigan and take up residence in other states to work until I could successfully return home to my family and live in my house again. If the insinuation is the Fed was paid back from the money collected from these gamblers, you are correct. However, Labor (and I include myself even though I am managerial) did pay a price in lost jobs, lower salaries, and additional costs to save our own butts. Jamie and the rest of the banking and investment firms have not offered any payments for what they did to Main Street.
To your point on partial government ownership of public enterprises, it may instill a level of sanity to them. It may force these companies to repatrinate profits made overseas back to the US. It may force companies moving manufacturing to escape the Overhead costs of manufacturing in the US, and returning to sell their product in the largest consuming nation in the world, to stay in the US. Does comparatiuve advantage consider the costs or the ability to pollute in one country as compared to not polluting in a home country? I am wandering here since you openned the door to a partial government involvement.
Well, we de facto got partial nationalization of GM temporarily as part of its bailoout. several other nations did this after 2008 without it being a big deal, so not a big deal to me either, although obviously likely to be mofe resistance here than elsewhere.
I have read the Bair column and have mixed feelings, comparing it to the longstanding stronger arguments of Dean Baker, who has always nodded to Bair, that we should have just let those big banks go bust in 2008 and let the FDIC sort out the mess, probably in that case needing to run to Congress to replenish its funds to pay off the really large numbers of bank customers who would have needed to be recompensed.
The tougher issue, which I see Bair eliding, and maybe Robert here not quite addressing, is not whether the bailout made money or not, which I think is really a sideshow, nice it did but big deal. No, it is back to the Bagehot-Minsky-Kindleberger-Bernanke-1931 question: would failing to do something drastic in Fall 2008 have led to a 1931 full-scale global financial collapse and new Great Depression. Bair does not address this clearly, while Dean Baker more or less dismisses it. But I find it not so easily dismissable and the strongest argument for retaining at least some of these powers Congress has removed from the Fed.
Bair does seem to recognize that there was a case for a “one off” use of extraordinary measures in 2008 (and some sort of nationalization might be an alternarive), but is vague about it. What she clearly does not like is the idea of these powers being around to use too easily or frequently, and the case for that concern is reasonable
Having read your recommendation “The Alchemists,” I would not question where we were heading which would be a far greater collapse if Bernanke and The Fed had not reacted as swiftly as it did. The bumbling crowd called Congress would have allowed months to have passed before coming to some consensus and it would have been small in comparison . . . witness the stimulus passed by Obama and which could have been larger. I am just not happy with the reactions to main street, the willingness to blow up automotive, and the willingness to save Wall Street and allow the former two to fail if need be.
It is my fault I have not read Bair. Been doing something else in preparation, which if accepted, will be exciting, and having come to me due to my words on healthcare.
Run I defended the bailout not the bankers. TARP QE1 Fannie Freddie rescue etc did not cause the damage on Main Street. The bankers, shadow bankers and AIG FP metabankers managed that without help from the Treasury or the Fed.
Barkley, I think the fact that the bailout generated huge profits, the largest profits ever obtained in all of human history, is not a sideshow. If the Fed and Treasury can make succeed in business without really trying, then the market system is much more grossly inefficient than it seemed even in 2008.
The huge gigantic unprecedented profits were earned by agents which borrowed at 0.25% (not needing to pay so much) and invested in risky assets. There was the risk of losses if there were another recession. Those who detest automatic stabilizers consider this a drawback. Sane people see it is an additional advantage from partial public ownership of the means of production.
I guess things are back to the old normal now. I’m sure that includes future crises which were normal before FDR and have become normal after Reagan. But beyond that, normal isn’t good enough. In theory partial nationalization would cause a Pareto improvement with EV in the trillions. The evidence (for once) very strongly supports theory. It makes no sense to leave $ 1,000,000,000,000 lying on the sidwalk out of fear of the word socialism (which doesn’t even scare people anymore)
Not to be annoying, how were they able to pull off what they did?
What happened from the eighties onward between the Fed, Congress, Comptroller Office, etc.? There is a whole history of actions and events taken by each of these entities which gave Wall Street and banks the ability to act in the way they did. Brooksley Born, Senator Dorgan, Iris Mack, etc. warned of it? Summers had a comment about LTCM when he was trying to untangle the mess left by it.
Guys, cycles end. Much like now, strains were growing in 2007 with debt capacity of consumers. The mortgage crisis itself may have been a trigger for the bigger mess by late summer 2008, but consumer spending is a debt based operation in capitalism and always has been the initial trigger.
This is why spreads blew out last October when the market noticed future revolving consumer debt was signaling a deleveraging which ended up being the December “crash”. The mortgage debt boom is a good example of stopping debt expansion. The bailout should have never happened and instead they should have failed with federal control of the banking system increased as this time, I agree with Baker. The bailout was pure junk
Lucky this cycle, we just see peaking consumer debt to corporate debt, which is typical, with little signs of other systematic debt issues. Though the “Bernanke” worry is the so called high quality debt gets hit as well due to its really junk and becomes junk bonds. I hope he is wrong on that. I expect junk bonds to crash later this summer into the fall. They are overvalued and their cracks are showing. This will be the signal of a incoming recession as business slows spending to match consumption, with the mortgage market being the laggard this time. But the high rated stuff? That is 1929-30 type of disaster in the making that spreads into the banking sector after that. Hopefully Bernanke is wrong.
Of course Uncle Trump is trying to his hardest for the crash to fulfill its real meaning.
No corporation would have settled for a mere return of principle and interest in exchange for assuming the risk which those failing banks and other corporations represented. What the US government did should be described as picking up nickels in front of a steamroller.
From the Sheila Bair article:
“The last catastrophe saw 9 million jobs lost, 8 million homes gone. A lost decade for most of America.”
I would add another loss to the people of the United States.
From 2008 to 2017 inclusive, the national debt had increased by $11,237Billion. During the previous 10 years the national debt had increased by $3,595Billions and that period included very expensive wars.
Where do you think that additional $7.642Trillion of federal spending went if not to prop up the US economy?
National debt in billions at the end of the 3rd quarter of the year.
Year ———- Debt ———- % of GDP —- Increase in Dollars —– Increase in %
1998 ———- $5,526———-61% ———- $113 ———————- 2.09%
1999 ———- $5,656———-58% ———- $130 ———————- 2.35%
2000 ———- $5,674 ———- 55% ———- $18 ———————- 0.32%
2001 ———- $5,807 ———- 55% ———- $133 ——————– 2.34%
2002 ———- $6,228 ———- 57% ———- $421 ——————– 7.25%
2003 ———- $6,783 ———- 59% ———- $555 ——————– 8.91%
2004 ———- $7,379 ———- 60% ———- $596 ——————– 8.79%
2005 ———- $7,933 ———- 60% ———- $554 ——————– 7.51%
2006 ———- $8,507 ———- 61% ———- $574 ——————– 7.24%
2007 ———- $9,008 ———- 62% ———- $501 ——————– 5.89%
2008 ———- $10,025 ——— 68% ——— $1,017 —————— 11.29%
2009 ———- $11,910 ———- 83% ——— $1,885 —————– 18.80%
2010 ———- $13,562 ———- 90% ——— $1,652 —————– 13.87%
2011 ———- $14,790 ———- 95% ——— $1,228 ——————- 9.05%
2012 ———- $16,066 ———- 99% ——— $1,276 ——————- 8.63%
2013 ———- $16,738 ———- 99% ———- $672 ——————– 4.18%
2014 ———- $17,824 ——— 101% ——— $1,086 ——————– 6.49%
2015 ———- $18,151 ———- 99% ———– $327 ——————– 1.83%
2016 ———- $19,573 ——— 104% ——— $1,422 ——————- 7.83%
2017 ———- $20,245 ——— 103% ———- $672 ——————- 3.43%
2018 ———- $21,478 (est.)— 107% ——— $1,233 ——————- 6.09%
Indeed it would have been unwise for any corporation to do what the Treasury and Fed did. Similarly it would be unwise for me to loan all of my wealth to someone who wanted to buy a house. If the mortgager defaulted, I would be bankrupt before I managed to forclose and sell.
Your point is that the cost of bearing risk is greater for corporations than for the US Federal Government. That explains why it was good policy (totally aside from preventing the second great depression) for the Federal Governement to buy risky assets even though it paid more than any entity with less risk bearing capacity (that is any entity on planet earth) would be willing to pay or wise to pay.
That is my point. Risky assets are worth more to the US Federal Government than to anything else on Earth, so it can achieve a Pareto improvement by buying some, so it should buy some.
The (approximately) correct way to score is the expected effect on the national debt after 10 years. This is the way everything else is scored. Congress specifically made special rules for the bailouts, because the alternative would be to say that (partial) socialism is more efficient than pure capitalism & they will not accept that obvious fact. This is only approximate, as the Federal Government bearing (reallty hiding) risk is an automatic stabilizer, so it should not be risk neutral but rather risk seeking.
The point is that the assets were worth much more to the Federal Government than to anyone else, so it could profit (correctly calculated) even ignoring the gigantic beneficial externalities while paying more than anyone else would pay.
If your point is that the US government can do what private corporations can not, then my question is, why is that important? Just because you can do something, does not mean that you should.
I do not consider bailing out huge corporations or banks to be positive in any sense. How are we to ever weed out the worst of the banks or other corporations? Currently in the US we have pseudo private enterprise.
Very often we are told that the federal government should stay out of the market economy. The corporate world regularly denounces regulations claiming that they know best. And the US Congress in its infinite wisdom bows to their wishes!
This works well, until the corporate geniuses crash the economy and seriously harm innocent bystanders in the mainstream economy!
Then bankers rush to the US Congress and warn of a complete economic shutdown if they are not bailed out. (Their regulators demand BAZOOKAS to address the problem!) And the US Congress in its infinite wisdom again bows to their wishes!
When these corporations fail, the federal government should extract that same quantity of flesh that other lenders of last resort would demand.
Warren Buffet bailed out Bank of America 2 years after the worst of the crash and has profited very handsomely.
“The latter resulted in a particularly big payday for Berkshire. Buffett invested $5 billion in Bank of America preferred stock in 2011 that paid a 6% annual dividend. In addition to his preferred stock, Buffett also received warrants to purchase 700 million shares for just $7.14 per share, which was about how much the bank’s stock was trading for at the time.
Well, Buffett exercised Berkshire’s warrants in 2017. As I write this, Bank of America trades for about $31 per share, making the value of Berkshire’s shares (the company ended up with 679 million) about $21 billion — a profit of roughly $16 billion in the seven years since the investment was made. Plus, the investment now pays Berkshire more than $400 million per year in dividends, which is substantially more than the preferred stock was paying.
If the US Congress is so terrified of socialism then let all the failed banks go bankrupt!
In the worst of cases the federal government could drop hundred dollar bills out of helicopters, from coast to coast.