It has been 10 years since the federal government took emergency actions in response to the financial crisis of 2008. Were those expensive interventions good investments? Or were they just bailouts for wealthy bankers?
Many economists believe that the policies—including the Troubled Asset Relief Program (TARP), the Housing and Economic Recovery Act of 2008, and others—were necessary to avert even greater economic harm. But consensus remains elusive. Some argue that even more aggressive rescue policies were called for. Others claim that more institutions should have been allowed to fail.
Popular perceptions are also mixed. A common narrative is that ordinary taxpayers were forced to pay trillions of dollars to rescue rich bankers. Others cite tallies showing net costs to taxpayers that were modest or even negative, because the money was paid back. Certainly, political distaste for the bailouts influenced key provisions of the Dodd-Frank Act of 2011, which made sweeping changes to the regulatory landscape with the stated intent of forever ending bailouts.
Perhaps the most fundamental question about bailouts is whether and when their benefits justify their costs. This is not an easy question to answer, but accurate cost assessment is also essential to address other questions: Did the likely benefits of the policy justify the expense? Could the benefits have been achieved at a lower cost?
Drawing on existing cost estimates and augmenting those with new calculations, I conclude that the total direct cost on a fair-value basis of crisis-related bailouts in the U.S. was about $498 billion. My analysis imposes the discipline of a fair-value approach, which incorporates the uncertainty about the size of eventual losses at the time assistance was extended and the cost of that risk. By contrast, popular accounts simply add up realized cash flows or tally total risk exposures.
That cost is big enough to raise serious questions about whether taxpayers could have been better protected. At the same time, it is small enough to ask whether Dodd-Frank’s goal of eliminating bailouts entirely justifies the costs it has imposed on financial institutions, and suggests revisiting some of the regulations that were hastily put into place after the crisis.
At the time the bailouts occurred, the largest direct beneficiaries were the unsecured creditors of large financial institutions, most significantly of Fannie Mae , Freddie Mac, AIG, and large banks. The exact identify of the creditors is not publicly known, but the group includes financial institutions, mutual funds, and ultimately debt investors from around the world. Shareholders of the bailed-out institutions benefited less than the popular perception—in fact, most were wiped out.
Mortgage borrowers, students, and others who took out loans from government lending programs and large bank depositors also received substantial assistance at taxpayers’ expense. Although this has gotten much less attention from the popular press, significant bailouts arose from pre-existing federal guarantee and loan programs—including the Federal Housing Administration (FHA), Federal Deposit Insurance Corporation (FDIC), and federal student loans. The bailout of the FHA is noteworthy because of the FHA’s similarity to Fannie and Freddie in having provided large volumes of underpriced mortgage guarantees and then realizing large losses when house prices crashed. The silent $60 billion bailout of the FHA occurred under the cover of the relatively opaque way the program is budgeted and accounted for.
Deposit insurance through the FDIC was massively expanded, exposing the government to enormous new potential losses. However, the FDIC is required to recover losses with ex post assessments on solvent banks when its funds are depleted, making it unlikely that taxpayers would be on the hook. Hence the expanded FDIC coverage qualified as a bailout of previously uninsured depositors, though not a large one.
Another issue that’s gotten relatively little attention involves the Federal Reserve’s emergency facilities, which provided liquidity to short-term funding markets by lending against risky collateral. My conclusion is that although the facilities put trillions of dollars potentially at risk, the bailout element was small. Importantly, many of the transactions were short-term and quite safe. For the riskier transactions, potential losses were backstopped by TARP funds rather than by the Fed.
Read the full post at Barron’s
Deborah Lucas is the Sloan Distinguished Professor of Finance at MIT’s Sloan School of Management, and the Director of the MIT Golub Center for Finance and Policy.