If libertarians had been calling the shots in Washington in the fall of 2008, the United States might now be in a second Great Depression. That’s because a failure to bail out key financial institutions – particularly AIG – might have caused a complete meltdown of capital markets and the collapse of the U.S. economy.
I say “might” because we’ll never know what would have happened in the absence of TARP and the Fed’s actions. But it’s hard to imagine why anyone would have wanted to roll the dice with so much at stake. Read Henry Paulson’s memoirs if you have forgotten the horrific details about how the collapse of AIG and Citigroup could have triggered a truly unstoppable contagion.
National leaders need to be pragmatic, especially in the very gravest of crises – whether it’s entering into an alliance with Stalinist Russia to beat the Nazis or bailing out the irresponsible institutions that caused the financial crisis of 2008. When the nation has a gun to its head, the last thing you want are purist leaders who inflexibly govern based on ideology.
Yes, there were plenty of things to hate about the bailout. It not only saved the bad guys from a fate they deserved, but did almost nothing for the millions of ordinary people who got sucked into the vortex caused by this recklessness. (Despite the fact that TARP included strong elements aimed at helping Main Street.) The implementation of TARP was poorly managed and the government asked too little from the banks in return, squandering an opportunity for reform. Nobody from either political party liked this bailout, but it was backed by a bipartisan majority in Congress who knew that the stakes were simply too high to do nothing.
Critics say that the bailout may encourage even more bad behavior in the future by leading bankers to think that the government will be there to save them. But this moral hazard critique is overblown. The government has a long history of letting businesses collapse – think of all the companies that went under between 2000 and 2003, including Enron and WorldCom. And even in the financial crisis, several huge firms disappeared: Bear Sterns, Lehman Brothers, and Merrill Lynch. Citigroup barely survives and has never recovered its value. Many masters of the universe lost their shirts. I can’t imagine that the lesson anyone would drew here is that it’s perfectly fine to blow up your firm with outsized risks because Uncle Sam will come to the rescue. Just look at the recent collapse of MF Global.
The bailout represented an exceptional response to an exceptional crisis – not the new norm. That is not to say that future bailouts won’t happen; I’m sure they will – and should – if the stakes are again that high. But I expect this will be a rare occurrence.
As for the policy interventions since the bailout – including the stimulus and Dodd-Frank – I believe the Obama administration has worked in the right direction, but could have done better. The stimulus made a difference, but would have had more impact if it were larger and less weighted toward tax cuts. Dodd-Frank will curb some of the worst abuses – and the Consumer Financial Protection Bureau is especially important – but the jury is still out on whether the law will truly rein in Wall Street.
Three years after the financial crisis, we still need more stimulus to get the economy going and stronger watchdogs to police the financial system.