Did they work?
With the financial meltdown finally contained and the Year of the Bailout drawing to a close, we can start to make some meaningful assessments about whether hundreds of corporate rescue packages did more harm than good. It's probably fair to say that aggressive government intervention in the economy, starting with the Bear Stearns bailout in March 2008, prevented a deeper collapse and maybe even a depression. But the government also erred on the side of doing too much and propped up some huge, mismanaged companies that would have, and perhaps should have, failed. To gauge the consequences of all the bailouts, I spoke recently with Barry Ritholtz, author of Bailout Nation and CEO of research firm FusionIQ. Excerpts:
Have any of these been good bailouts? I can imagine a bailout done well. Washington Mutual might be the closest example. Once the FDIC identified that bank as insolvent [in September 2008], they effectively came in on Friday night and carried out an orderly reorganization. They fired the board, the common stock ended up worthless, and by Monday morning, they had already sold key assets to JPMorgan Chase. The toxic debt and the shareholders were wiped out, and the bondholders took a big haircut. I don't know if we'd call that a bailout, but it was not a reckless collapse like Lehman Brothers. And it didn't cost the taxpayers anything.
The ideal bailout is not a bailout of reckless financiers. It's like the government equivalent of a hospice for dying companies, involving no taxpayer money and no moral hazard. And the people who behaved recklessly, they get their comeuppance.
The most egregious bailout, that's a tossup between Citigroup and AIG. I think AIG was worse just because it involved so much money. And there's no way we're going to see all of that back. It could end up being the greatest theft in history.
Citi is a perennial debacle. They were clearly insolvent. They were too big to fail but also too big to succeed. They had lobbied for the repeal of the Glass-Steagall Act for 10 years before it actually happened. They started in the late '80s, when they realized they were limited in terms of growth and the only way to really grow would be to buy other companies on other side of the investment business. To do that, they needed the repeal of Glass-Steagall. The bailout was the classic example of saving the bank instead of saving the banking system.
What would have been a better way to deal with AIG? There was a simple solution. AIG was basically a AAA-rated, conservatively run insurance company with a hedge fund hidden under its skirts—AIG Financial Products. It looked to them like they were making free money: selling $3 trillion worth of risk and taking 10 basis points [of profit] on it. It was like going to Vegas. If you play in the casinos and you win, then the Nevada Gaming Commission is going to make sure the casino pays. But if you play craps with some guys out in the alley and you win, there's nobody there to make sure they pay. AIG Financial Products was like that craps game in the alley.
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We could have done this by cleaving FP from the insurance company. So anybody owed debts by FP would have been dealing with FP alone. And if they didn't get their money back, too bad. You're supposed to lose money when you put it into insolvent companies. You're supposed to suffer pain and agony when you put money into a company that's as corrupt as that AIG hedge fund. Then we could have spun out AIG the insurance company in 30 days, as a stand-alone entity, without FP.
Then wind down FP separately. That should have been demonized and pulled out and closed. To throw $185 billion at AIG to save them, the whole thing is pointless. The best thing would have been to just rip the Band-Aid off.
Could the feds have done this in 2008? Or only earlier, before the crisis hit? Yes, we could have done it in September 2008. The problem is there's psychological pain, and we humans always want to put off the pain. I see this all the time in investing. When people buy a stock at 80, they know they're taking a risk, then it falls to 3 and the phone call comes asking, "What should I do?" When you ask what do they want, usually the subtext is, "I want the pain to stop." So to make the pain stop, you just sell the damn thing. That's what we did with AIG. We just wanted the pain to stop.
Wasn't the Fed hamstrung? The Fed was in a position where it couldn't do nothing, but it could have done something more creative. The way I see it, if a company blows itself up the way AIG and Citigroup did, in a capitalist system, you have to take it out back and put it down like Old Yeller.
By the way, there was a huge amount of capital in private trusts and partnerships and private investments. Not one of those blew up. When it's a public firm, you can't go after senior executives' personal assets if it collapses. But if it's a private operation, you can. And none of the guys with their own money on the line went belly up.
What would have been a better way to handle Citi? They should have been WaMued: put into receivership. The FDIC fires the board, and stockholders get wiped out. Bondholders get what's left over, given their priority in the capital structure. The government could have said, "We'll see how close we can come to making you whole," but they probably would have been down 30, 40, maybe 50 percent. Then they could have spun out Smith Barney, a nice, profitable brokerage firm. The bank, Citibank, they could have spun that out as a stand-alone, with its $1 trillion in deposits. Pull out the toxic sludge. Another dozen entities within Citigroup either get spun off, if there are buyers, or just shut down. That's what happens to bankrupt companies.
They could have done the same with Bank of America. Spin out Merrill Lynch, sell off Countrywide as a mortgage broker, and the senior management and the board—they get jack.
It's conventional wisdom on Wall Street that the government made a mistake in letting Lehman Brothers collapse last September. But some people think the real mistake was rescuing Bear Stearns a few months earlier, since that led Lehman to expect a rescue. Bear Stearns was an organized collapse. They could have just let Bear Stearns go down. JPMorgan supposedly had 40 percent of the $9 trillion in Bear's derivatives exposure, so why not let JPMorgan deal with it? After the Fed saved Bear, Dick Fuld [CEO of Lehman Brothers] sees Warren Buffett come in with a bunch of billions. That's supposedly how much he offered: "A bunch of billions." At a pretty good rate. And Fuld turns him down! He must have been thinking he'd get a better deal from the government. Classic moral hazard! So now it's September, the night before bankruptcy, and Fuld is meeting with the Fed and the Treasury. Boy, would I have liked to be a fly on the wall. You can just imagine Paulson and Bernanke saying, "You turned Buffett down? You made the mistake of turning Warren Buffett down? And now you want money from us?" No wonder they didn't want to bail out Lehman—even if they could have.
Goldman Sachs ended up with just about the best deal of all. Not just the $10 billion federal bailout, which it paid back, but all that extra money from the AIG bailout. It's astonishing that Goldman Sachs walked away with what they did. As an AIG counterparty, they got $13 billion from the AIG bailout. That's on top of the $5.9 billion they grabbed on the eve of AIG's collapse. It's just so egregious.
What do you think of the idea that Goldman got special treatment just because Hank Paulson, the t reasury s ecretary under Bush, had been Goldman CEO right before coming to Washington ? I don't know, but it's certainly true that no Wall Street house has more people strewn throughout the Treasury and the Federal Reserve Bank of New York than Goldman. And if AIG had gone through bankruptcy, Goldman would have been $19 billion poorer. Goldman is the only counterparty I know that through the whole thing got bailouts at 100 cents on the dollar. It was an unbelievable transfer of wealth from taxpayers to reckless companies.
What do you think of the auto bailouts? At least those companies had to testify before Congress and present a public plan saying what their problems were and what they needed. Plus, they got put into bankruptcy. That was certainly better than just throwing a trillion dollars at them.
Are we learning the right lessons? The American public is notorious for its short attention span. They were paying attention for a while, but if another celebrity dies or there's an Elvis sighting, forget it.
Rahm Emanuel likes to say that you shouldn't waste a good crisis, but I think we have. I don't understand why the rating agencies haven't been given the Arthur Andersen treatment. Instead, we get this bill about credit card practices that has absolutely nothing to do with what just happened. Once the markets started moving back up again after bottoming out in March, it might have been too late for real reform. The Obama administration dawdled. I don't think they expected as much of a rally as we've had since March. And now the lobbyists for Wall Street have taken over. It's on to the next issue—so now we've got a healthcare reform debate. They should have taken care of the first crying baby before picking up the next one.
Do you think anything good will come out of all this? No. Benjamin Disraeli said, "The one thing we learn from history is that we learn nothing from history." My biggest fear is we revert to business as usual—until the next crisis.