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Federal Bailouts Unpredictable

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The Associated Press

Published: September 22, 2008

CHICAGO - The stock market plummets, investors pull out money and loans dry up, triggering global financial turmoil. Enter the government, buying up bad mortgages and other problem assets.

This scenario from the 1930s sounds eerily current, in part because the Bush administration is taking pages from the playbooks Presidents Hoover and Franklin Roosevelt used to unfreeze credit and keep Americans from losing their homes three-quarters of a century ago.

From the Great Depression to the Chrysler bailout in 1979 to the savings and loan crisis that cost taxpayers $125 billion in the 1990s, the Bush administration has many government interventions from which to learn. If the history of previous bailouts holds a single lesson, it's that outcomes are unpredictable and the problems will take years to work out.

"Some of these measures have been effective in propping up the economy at times when our private sector needed a little help," said Scott Anderson, senior economist at Wells Fargo Economics.

"And that's the role of the government. But in the long term, there are negatives."

A student of the Depression, Federal Reserve Chairman Ben Bernanke well knows that the government's slowness to step in after the Crash of 1929 is often blamed for contributing to what turned out to be a full decade of economic misery. By the time the government took comprehensive action, unemployment was 25 percent, much of the steel business had disappeared, and thousands of homeowners a week were losing their houses to banks.

The Hoover administration created the Reconstruction Finance Corp. in 1932 to spur the economy by lending money to financial, industrial and agricultural institutions and injecting money into thousands of banks by investing in their preferred stock.

The RFC fared well financially and did not ultimately prove a costly burden for taxpayers, said Richard Sylla, financial historian and economist at New York University's Stern School of Business. By the time it closed shop in 1957, it had made loans of about $50 billion.

The same held true for the Home Owners' Loan Corp., started under Roosevelt in 1933 as part of the New Deal. The agency helped stop a flood of foreclosures by buying $3 billion worth of defaulted mortgages and refinancing more than 1 million loans at lower rates and longer terms.

After a wave of bank failures, the government created the Federal Deposit Insurance Corp. that year, guaranteeing the safety of checking and savings deposits in member banks.

As with many interventions, the notion of government putting taxpayers on the hook for a huge financial burden was not popular at first.

"The 1930s reforms were detested at the time," Sylla said on the initial public reaction. "But later on people said they really were pretty good."

The 1970s and 1980s brought a series of government rescues of corporations, including Lockheed and Continental Illinois National Bank and Trust. But none was more heralded than the 1979 bailout of Chrysler Corp. The nation's 10th-largest company had fallen into near-collapse amid high oil prices that tanked demand for its big cars. President Carter's administration arranged for $1.2 billion in subsidized loans. That spurred a Chrysler comeback and ultimately netted a profit for the government when Chrysler made good on its obligations.

The Chrysler bailout is widely regarded as a success. But Barry Ritholtz, who writes the popular financial blog The Big Picture and is chief executive of research firm FusionIQ, argues in a soon-to-be-published book, "Bailout Nation," that it really helped to cause the decline of the auto industry. Automakers kept doing business as usual after the rescue, he said, rather than learning a needed lesson from Chrysler's decline and overhauling their attitude toward fuel efficiency and manufacturing quality.

"It's a slippery slope," he said of government intervention. "In theory, you shouldn't be doing any bailouts unless it's truly systemic risk."

The S&L crisis was the costliest intervention ever - until the current plan to buy up to $700 billion in mortgage-related assets.

It was caused by the industry's expansion into commercial real-estate lending in the wake of deregulation and amid poor oversight, not unlike the explosion of subprime mortgage lending two decades later.

With increasing numbers of savings and loan associations insolvent, doomed by higher interest rates, Congress in 1989 established the Resolution Trust Corp., a government-owned asset management company charged with taking over troubled assets and paying depositors their lost funds. By the time it wrapped up business in the mid-1990s, more than 700 S&Ls had failed.

OTHER INTERVENTIONS

A look at some U.S. government interventions and bailouts in the past century before this year's crisis on Wall Street:

1932 - The Hoover administration creates the Reconstruction Finance Corp. during the Great Depression to facilitate economic activity by lending money.

1933 - The Roosevelt administration creates the Home Owners' Loan Corp. to buy $3 billion in bad mortgages from banks and refinance them to homeowners to stem foreclosures. The government makes a small profit.

1971 - Congress saves Lockheed Aircraft Corp., the nation's biggest defense contractor, from bankruptcy by guaranteeing the repayment of $250 million in bank loans.

1979 - Congress and the Carter administration arrange for $1.2 billion in subsidized loans to bail out automaker Chrysler Corp., then the nation's 10th-largest company. There was no significant cost to the government, since the loans were repaid.

1984 - Congress effectively takes over the ailing Continental Illinois National Bank and Trust, which failed with $40 billion of assets. The Federal Deposit Insurance Corp. injects $4.5 billion to buy bad loans.

1989 - Congress establishes the Resolution Trust Corp. to take over bad assets and make depositors whole. Resolving the S&L crisis takes six years and $125 billion in taxpayer money - roughly equal to $200 billion in today's dollars.

1998 - The government brokers a $3.6 billion private bailout in the collapse of the Long-Term Capital Management hedge fund, although no government money is involved.

2001 - Congress authorizes $5 billion in cash after the Sept. 11 attacks to help shore up the airline industry and follows up with $10 billion in loan guarantees.

Source: The Associated Press

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