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Bailouts: too big a crutch?

Some say the lifelines are cheaper in the long run. Critics say they reward bad behavior.

September 17, 2008|Michael A. Hiltzik | Times Staff Writer

How far will the bailout binge go?

So far this year, the federal government has put up nearly $30 billion to avert a major financial default by the investment bank Bear Stearns Cos.; committed to investing as much as $200 billion in preferred stock of the loss-plagued finance giants Fannie Mae and Freddie Mac and at least $5 billion in their mortgage securities; and agreed to provide an emergency loan of $85 billion to American International Group Inc. in return for an ownership stake of as much as 80% in the stricken insurance giant.

Tuesday's helping hand to AIG bailed out not only that company, which was contemplating a bankruptcy filing as early as today, but also countless trading partners of the firm, including investment banks that had failed to raise the massive loans themselves.

Thus far, only one major supplicant for federal assistance has been turned away: investment bank Lehman Bros. Holdings Inc., which was refused a bailout by Treasury Secretary Henry M. Paulson Jr. last weekend and filed for bankruptcy protection Monday. Meanwhile, Congress is contemplating a loan program of $25 billion to $50 billion for automakers.

This year's bailouts add up to an unprecedented surge of direct financial intervention by the government in the nation's private sector -- a cornucopia of handouts and guarantees dwarfing the rescue of the savings and loan industry in the 1980s, which ended up costing taxpayers some $124 billion.

In each case, industry and government officials have justified the bailout as cheaper in the long run than doing nothing. But critics contend that bailouts often encourage bad behavior by relieving underperforming industries of the consequences of their ineptitude.

In addition, sometimes the government can end up as an investor in companies that are the target of regulatory action, creating a conflict of interest. The government's potential ownership of AIG could put policymakers at cross-purposes with their own efforts to regulate a variety of financial transactions in which the company participates.

The situation is bound to raise thorny policy issues for the next president, who is likely to face further demands for assistance from mortgage lenders, home builders, automakers and other struggling industries. Economic and legal experts say Congress and regulators need a set of standards for how to treat industries and companies with their hands out, especially when the requests come in an atmosphere of crisis.

"The more the government steps in, the more there are people who want the government to step in," says Peter J. Wallison, a research fellow at the American Enterprise Institute and a former White House and Treasury Department official. "Every time you do it, that creates an equitable argument for someone else to get bailed out."

The president and Congress will also have to decide what sort of concessions to demand from recipients of public largess. For example, only days after the Treasury Department announced the Fannie Mae and Freddie Mac bailout this month, several Senate Democrats proposed that the mortgage companies freeze foreclosures for at least 90 days.

A loan guarantee package for the auto industry is likely to be one of the most closely watched measures in Congress this year. U.S. automakers contend that financial help is warranted because the cost of redesigning their products to meet federally mandated mileage standards by a 2020 deadline will be staggering.

That could provide a template for a similar appeal from airlines, which could argue that the costs of fuel and security measures are hobbling them.

Without more open rules governing the decision-making process, the entities with the most potent lobbyists may get bailouts, putting competitors at a disadvantage.

"We don't have any rules about whether the government should get involved or not," says Cheryl Block, a law professor at Washington University in St. Louis who has followed the bailout issue since the 1990s. "Certain things happen in the middle of the night, and no one knows who's in the meeting."

For now, the decisions seem to be based on a sense that an entity is "too big to fail."

Such concerns drove the bailout of Fannie Mae and Freddie Mac, which together back half of all U.S. residential mortgages. Their failure, government officials feared, could choke off the supply of mortgage credit or drive up mortgage interest rates to levels that would impede recovery for the country's beleaguered housing market.

"Fannie and Freddie define what's 'too big to fail,' " says Jared Bernstein, an economist at the Economic Policy Institute.

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