Bailouts: too big a crutch?

But a company need not be the biggest in its industry to pass the "too big to fail" test. Bear Stearns was the nation's fifth-ranked investment bank in terms of assets when the Federal Reserve and the Treasury arranged its emergency sale to JPMorgan Chase & Co. in March. Bear Stearns' deal-making, though, extended deeply into the financial derivatives markets, raising fears that its sudden collapse would produce a tidal wave of defaults around the globe, shattering the confidence necessary to keep the international credit markets functioning smoothly.

The interventions surrounding Bear Stearns and Fannie/Freddie suggest that government officials have been fairly successful at distinguishing cases in which a company's failure would have broad "systemic risk," and acting only in those cases, says Laurent Jacque, professor of international finance and banking at Tufts University.

Still, some economists believe that the "too big to fail" standard, if too loosely applied, can lead to imprudent risk-taking by big companies.

"To the extent that creditors of TBTF banks expect government protection, they reduce their vigilance in monitoring . . . these banks' activities," wrote Gary H. Stern and Ron Feldman, two high-ranking Fed officials, in 2004.

"The case could be made that there's a shift on the part of the political establishment in favor of bailouts," says Robert Bliss, a former senior financial economist at the Federal Reserve Bank of Chicago who is now a business professor at Wake Forest University.

Presidential politics may be driving the recent rush toward government assistance. In June, Republican candidate Sen. John McCain drew a line against the auto industry bailouts during an appearance in Ohio, saying, "I just don't see a scenario where the federal government would come in and bail out any industry in America today."

As Michigan's importance as a swing state in the presidential race grew, however, McCain changed his tune. In August he proclaimed, "We should fund [the loan program] and take action that will assist Detroit and its suppliers in making it through this difficult time of transition."

Democratic nominee Sen. Barack Obama also supports the auto loans.

Bailouts have long been a part, albeit a controversial one, of U.S. policymaking.