As part of an effort to better understand Republican economic doctrine, I’ve been trying to figure out why conservatives hate the bank bailouts that occurred during the Great Recession. I would have thought that not allowing your country’s banking system to collapse was a good thing. Republican dogma, though, regards failure as a principled imperative.
Bank bailouts create a “moral hazard” by giving bankers incentive to take risks. That sounds logical, especially if you are untroubled by the businesses and jobs that go under along with banks. But is there any evidence that moralizing works on bankers?
Okay, that was a moment of levity. The real question is whether there is evidence that even Republicans believe their “moral hazard” construct. Bailouts for banks, industries, and companies have been a bipartisan factor in the American economy at least since the Great Depression, probably because of the Great Depression. Consider the history.[i]
- 1933: Franklin Roosevelt begins the long slog to save capitalism from itself and us from it.
- 1971: Richard Nixon guarantees loans to Lockheed, netting the government $112 million.
- 1974: Richard Nixon starts what will become a $7.8 billion rescue of Franklin National Bank.
- 1976: Gerald Ford reorganizes Penn Central and other bankrupt railroads into Conrail for freight service and Amtrak for passengers. Amtrak struggles, but Conrail is so profitable that it embarrasses “market fundamentalists in the Reagan administration.” They eventually sell it for “a mortifyingly high $1.65 billion.”
- 1980: Jimmy Carter guarantees loans for Chrysler that will net the government $660 million.
- 1982: Ronald Reagan starts 4 years of relief during the Latin American Debt Crisis to mitigate impact on major U.S. banks.
- 1984: Ronald Reagan takes an 80% share of Continental Illinois National Bank and Trust Co.
- 1985: Ronald Reagan and George H. W. Bush, through the early 90s, watch as “the Fed continuously provided capital loans to many troubled banks” surreptitiously through its discount window.
- 1987: Ronald Reagan, watches the Fed “flooded the system with liquidity” after the October crash.
- 1989: George H. W. Bush bails out the Savings-and-Loans at a cost of $220 billion.
- 1990: George H. W. Bush bails out the Bank of New England and Citibank.
- 1994: Bill Clinton’s Treasury helps support Mexico to protect U.S. investors.
- 1998: Bill Clinton organized a private bailout of Long Term Capital Management hedge fund.
- 2001: George W. Bush, after 9/11, lends the airlines $10 billion and gives them $5 billion, still netting the Treasury between $140 million and $330 million.
- 2008: George W. Bush bails out everybody. For the status of the Great Recession bailouts, see Pro Publica.
Clearly, and appropriately, Presidents of both parties and their appointees value the preservation of companies, industries, and jobs over lessons on ethical behavior for the banking and financial sector. Let’s consider the three most telling of these bailouts.
In 1933, Franklin Roosevelt could not afford to moralize. He took office three and a half years after the crash of the stock market and after as many years of near inactivity by the Fed and Herbert Hoover.[ii] By Roosevelt’s inauguration, “the credit and currency machinery of the country had come to a grinding halt.” Moral lessons must have been everywhere, but to no avail. Roosevelt acted. He secured the financial system and instituted “a number of historically significant, precedent-setting government bailouts and rescue programs.” Of Roosevelt’s first week in office, Raymond Moley, who helped create the New Deal then turned against it would write, “Capitalism was saved in eight days.”
In 1984, following recessions and Congressional deregulation that encouraged risk taking (irony to the brim), the Continental Illinois National Bank and Trust Company failed. The Reagan administration – the Reagan administration – assumed an 80% share of the bank. Critically, the action was based on “prior panics in which a single failure or small group of failures resulted in panics, recessions, and depressions….”
In March of 2008, Bear Stearns, a major, global investment bank and brokerage firm, was holding tens of billions of dollars in bad mortgages. Its stock was in “free fall.” The Bush administration engineered a bailout by JPMorgan Chase and the New York Fed. Treasury Secretary Henry Paulson said that it was “to ensure the orderly function of financial markets.” Fannie Mae and Freddie Mac were in trouble due to their attempts to recover market share lost to private-label entities by taking the same risks that now were coming back to haunt those entities. They got nationalized. Then there was American International Group, AIG, the bailout of which had such punitive conditions that they later were ruled illegal. Paulson explained, “It was important that terms be harsh because I take moral hazard seriously….”
Perhaps, but he seems to regard moral hazard as a pleasantly elastic concept. In fact, the Reagan and Bush bailouts were tacit admissions that “moral hazard” is a medieval construct and that bailouts are necessary to a civilized version of capitalism. Stunningly, both of these administrations managed to prove the point by both positive and negative examples.
After bailing out Continental Illinois, Reagan did nothing as the Savings and Loan (S&L) sector, hurt by recessions and – yet again – a lack of oversight due to deregulation, collapsed. The crisis dragged on even after an eventual bailout act in 1989. It would cost $160 billion to resolve before it was done.
The Bush and Paulson failure is more complicated and far more consequential. Paulson had taken severe criticism for bailing out Bear Stearns. When Lehman Brothers, the fourth-largest investment bank in the United States, filed for bankruptcy in September 2008, Paulson tried to mount a private rescue. He failed and just quit. Later, he would claim that he had no legal way to put money directly into Lehman. That claim partly was because Bush did not have Roosevelt’s clear vision. Ben Bernanke at the Fed and Timothy Geithner at the New York Fed ruled that Lehman did not have enough collateral to be eligible for loans. That view was not unanimous at the New York Fed and “was a judgment call, not a matter of strict statute….”
The call was made, Lehman was allowed to go under, and the world’s financial system shuddered.
Bear Stearns had been rescued. AIG had been rescued. Fannie Mae and Freddie Mac had been rescued. Would saving Lehman have changed anything? That is not knowable, but Alan S. Blinder, an economics professor at Princeton and former vice chairman of the Fed, has said, “There is close to universal agreement that the demise of Lehman Brothers was the watershed event of the entire financial crisis and that the decision to allow it to fail was the watershed decision.”
“[T]he chaos that ensued forced the government to step in to protect almost every financial instrument involved in the credit markets ….” Morality was thrown to the winds, and Paulson proposed The Emergency Economic Stabilization Act of 2008. It authorized the Treasury Department to spend $700 billion to purchase or guarantee troubled assets through the "Troubled Asset Relief Program" (TARP).
The necessity and the success of bailouts have varied over time, but it is clear that not doing them has consequences and that they work when done right. Bailouts have saved businesses, industries, countless jobs, and capitalism itself, maybe twice.
Regulations also have worked. Despite slumps and recessions, regulations put in place after the Great Depression prevented catastrophic episodes. Then, we started chipping away at those regulations. The S&L crisis was an early warning about deregulation. It was ignored. Decades of more deregulation culminated in the Great Recession. We watched this happen. We lived this.
Allowing your banking system to collapse is not moral; it’s stupid. Bailouts work, and Republicans use them. Regulations work and also prevent the need for bailouts, but Republicans fight them at every turn. It’s not bailouts that conservatives hate, it’s regulations.
“Moral hazard” is a necessary smoke screen to cover Republican attacks on regulations launched under the guise of their Cult of the Free Market. If they use “free market” mythology to counter regulations, they hardly can be seen bailing out mismanaged companies. They will do exactly that, but, to cover their tracks, they continue to stoke hatred among their base for the very bailouts they rely on.
Even worse, while they fight to remove any bounds on the ability of the wealthiest and the most powerful among us to grow their wealth and their power, they fight harder to demolish the safety net that would protect the rest of us when the inevitable happens.
And it is inevitable. Greed never will go away. It is too much a part of us. Deregulation provides more encouragement to take risks than ever could be countered by conjecture about some absurd “moral hazard.” Deregulation is the hazard. Greed must be controlled, not proselytized to.
In what philosophy are regulations that prevent predation, fraud, and gambling with other people’s money worse than massive unemployment. In what philosophy are regulations that maintain stability in the financial sector worse than wide-spread bankruptcies? In what philosophy is safeguarding and preserving jobs and businesses by intervention worse than Great Recessions and Great Depressions? Apparently, it’s the Republican free-market philosophy.
In the end, then, there is a moral issue with bailouts. It’s just not the one that Republicans have in mind.
[i] The list that follows comes from Timothy Noah’s article in Slate, from Pro Publica, and from Kevin Phillips in “Wealth and Democracy” (where in he says Reagan, Bush I, and Clinton (2Rs and a D) put moral hazard down for good). Additional notes are from here or as noted in the list. Dollar amounts in the list are in 2008 dollars.
[ii] In the months after October of 1929, the Fed did reduce rates and inject money into the banking system, just too timidly. And in early summer of 1930, it reversed itself. The economy immediately worsened (which is saying something). The Fed also completely ignored the default of virtually all of central Europe in 1931 and, in 1932, defaulted on its own responsibility to be the lender of last resort. Hoover did try to save the farmers early on. Equally timid in his actions, especially regarding the banks, he also allowed a deficit budget. However, the government was too small relative to the GDP for his minimal effort to have an effect. Lesson 1: Be careful what you demagogue for. Lesson 2: When Nobel laureates and students of the Great Depression tell you that your stimulus is too small, your stimulus might be too small.