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.
Assistant Professor of Finance, MIT Sloan School of Management, Emil Verner
From The Hill
After a severe financial crisis, it’s common to see a surge in political polarization and in the popularity of populist parties, especially on the far right.
We’ve seen this decade after decade, and it’s clearly the case now around the world. Just look at the Law and Justice Party in Poland, Podemos in Spain and Jobbik in Hungary. The U.S. has certainly seen its share of political polarization, too.
This shift matters, as the emergence of far-right parties increases policy uncertainty and can threaten economic growth and democratic institutions. Those parties often bundle together radical economic platforms with xenophobic policies and racist rhetoric.
As a result, it’s important to understand whether (and how much) financial crises lead to increased support for extremist parties and why there is a connection.
In a recent study, my colleague and I analyzed these questions in the context of Hungary after the 2008 financial crisis. That country experienced a particularly severe household debt crisis starting in 2008 and a sharp increase in support for the far right.
Ever since I was a graduate student in economics, I’ve been struggling with the uncomfortable observation that economic theories often don’t seem to work in practice. That goes for that most influential economic theory, the Efficient Markets Hypothesis, which holds that investors are rational decision makers and market prices fully reflect all available information, that is, the “wisdom of crowds.”
Certainly, the principles of Efficient Markets are an excellent approximation to reality during normal business environments. It is one of the most useful, powerful, and beautiful pieces of economic reasoning that economists have ever proposed. It has saved generations of portfolio managers from bad investment decisions, democratizing finance along the way through passive investment vehicles like index funds.
Then came the Financial Crisis of 2008; the “wisdom of crowds” was replaced by the “madness of mobs.” Investors reacted emotionally and instinctively in response to extreme business environments — good or bad — leading either to irrational exuberance or panic selling.
“Are new regulations creating new problems for the housing market?”
“Has the federal government now become the subprime market?”
“Could the financial crisis happen again any time soon?”
These were just a few of the questions tackled by Deborah Lucas, the Distinguished Professor of Finance at MIT’s Sloan School of Management and the Director of the MIT Golub Center for Finance and Policy, during the #MITSloanExperts Twitter chat on October 30.
Joined by host Amy Resnick, editor of Pensions & Investments, she asked Lucas questions about the future of financial regulation and housing market finance reform, as well as ideas for fostering stronger ties between the regulatory and the academic communities.
Did you miss the chat? That’s OK, but we’ve encapsulated everything in the Storify below.
Deborah Lucas, the Distinguished Professor of Finance at MIT’s Sloan School of Management, and the Director of the MIT Golub Center for Finance and Policy, will discuss the 10-year anniversary of the financial crisis during an #MITSloanExperts Twitter chat on October 30 at 12 p.m. EDT.
As the 10-year anniversary of the great financial crisis approaches, Lucas will focus on answering what have we learned and whether we have made enough progress to prevent a repeat of something similar. Lucas’ recent research has focused on measuring and accounting for the costs and risks of government financial obligations. Her academic publications cover a wide range of topics including the effect of idiosyncratic risk on asset prices and portfolio choice, dynamic models of corporate finance, financial institutions, monetary economics, and valuation of government guarantees. An expert on federal credit programs, she has testified before Congress on budgeting for Fannie Mae and Freddie Mac, student loans, and on strategically important financial institutions.
The host of the chat will be Amy Resnick, editor of Pensions & Investments. Resnick will ask Lucas questions about the future of financial regulation and housing market finance reform, as well as ideas for fostering stronger ties between the regulatory and the academic communities.
To join the chat, be on Twitter on October 30 at 12 p.m. ET and follow the hashtag #MITSloanExperts. Questions can be submitted in advance or in real-time, using #MITSloanExperts.