In hindsight: Bailouts prevented another depression

Everyone is entitled to their own opinions, but not their own facts.

Too many political types bloviate about the Bush and Obama bailouts during the 2008 subprime crisis. They claim it failed, didn’t work and cost us taxpayers a lot.

I beg to differ.

In late 2008, people stopped spending…Restaurants were empty. Shopping malls were abandoned. Businesses froze. It felt like lemmings charging over a cliff.

Wall Street was in panic. Market makers were compromised because many were out of business or did not have the capital to buy and sell securities- essential to making markets. Wachovia, Merill Lynch, among others went into “arranged marriages” without a dowry. Washington Mutual went under as did Lehman Brothers. Banks refused to take each other’s credits.

The Great Depression of 1929 is in our DNA and seemed real.

There were runs on money markets. Liquidity disappeared. Hedge funds abandoned Morgan Stanley and Merrill Lynch because they didn’t want to have their funds tied up and lost. Goldman Saks was about to collapse, as were Citigroup and BankAmerica.

I lived through this and found that there were no safe places to hide.

While I had predicted the sub-prime crisis in 2006 (and had alerted the Federal Reserve, numerous elected officials and the Milwaukee Journal-Sentinel and New York Times), I had not anticipated AIG’s fall or that corporate bonds would be hit as hard as they were.

Mr. Paulson and Mr. Bernecke panicked like the rest of us. They reacted by throwing a lot of stuff against the wall to see what stuck. Finally some of what they did did stick, and the worst of the panic subsided. Obama and his crew continued with programs to stabilize the markets and the banks and to save the auto business and their suppliers.

I mention what happened because we have short memories and because I want to set the stage for my belief that what both the Bush and Obama governments avoided a 1929-like depression.

But don’t take my word; look at the July 25, 2011, article in Fortune Magazine titled “Surprise! The Big Bad Bailout is Paying Off.”

Fortune Magazine is not a tool of Occupy Wall Street or Liberals. Like most business people, they need to look at the world objectively. Their research showed that the
bailouts were a success.

The Fortune article considered the entire bailout, not just the 3 percent TARP (Troubled Asset Relief Program). TARP cost $19 billion, including a $13 billion restructuring cost for homeowners that stabilized neighborhoods. TARP was authorized to spend $700 billion but never spent more that $410 billion.

The Treasury guaranteed money market funds when the largest such fund, Reserve Prime Fund, fell to .97 cent. In plain parlance, Reserve broke the buck. The Treasury stopped a run on these funds when they guaranteed $3 trillion.

Hedge funds ran for the doors when Lehman Brothers – one of the top “Prime Brokers” – went under and their assets were frozen. There was a run on Goldman Saks and Morgan Stanley – also “Prime Brokers” that was stemmed when the government made them “banks” so the Federal Reserve could loan them money. 

Merrill Lynch joined Bank of America in a shot-gun marriage as did Countrywide.

GE Capital couldn’t rollover its borrowings, a problem other large companies faced. The government became the lender of last resort for these firms. 

AIG through a British subsidiary guaranteed a lot of AAA-rated bad CMOs and other mortgage backed bonds. As the country’s largest insurer, they needed time to unravel their assets. The Treasury got 563 million shares of AIG for making $85 billion in credit available. These shares are worth about $14 billion.

Was it smart to pay Goldman Saks, one of the worst offenders in the subprime crisis 100 percent on the dollar? Probably not, but to allow AIG to go belly up would have had a negative affect on the economy in part because other insurance companies would have had to take over their policies and annuities and they did not have the capital to do so..

The most critical and largest expense was for Fannie Mae/Freddie Mac. Shareholders were wiped out, but debt holders (many of which were banks) were saved. The cost as of last summer was $130 billion ($154 billion, less a $24 billion dividend). The Congressional Budget Office and the Treasury, according to Fortune, expect this number to shrink.

There were many problems with these two organizations. Fannie Mae was for the Democrats and Freddie Mac was for the Republicans. The original idea was that they would be a clearinghouse for mortgages on the secondary market (something I advocated for more than four decades ago).

These two organizations then became quasi government-private companies, combining the worst that public and private offers. Management was rewarded for short-term performance so they manipulated the system to ensure that their numbers looked good. Both Fannie Mae & Freddie Mac were generous in their political contributions and lobbying. The function of these two organizations should not be privatized.
Fortune believes that the negative part of the bailout was a ruling that AIG, Citigroup, GM and Ally Financial (formerly GMAC) could use their tax losses in full and could shelter $35 billion in income. Of course, they need to earn money to shelter them.

The current “losses” in Chrysler, GM and AIG are offset by gains from the banks (who were anxious to pay off their debt so that their top executives would not have a ceiling on their compensation). These bailouts fell from $$411 billion to $104 billion Final judgment is still out on Chrysler, GM & AIG.

Imagine for the moment the damage to our economy and society if GM, Chrysler and AIG failed. The actual cost to the government and taxpayers for unemployment and other expenses would have been higher than the bailout.

On the “Plus” side, Fortune included “bailout” profits from the Federal Reserve.

The Federal Reserve bought $1.25 trillion of mortgage backed securities in QE1 
(2008-9) and $600 billion in QE2 (2010-11). The Federal Reserve owns about $2 trillion for which they did not have to borrow. In 2007-8, the Fed returned to the Treasury $193 billion (which Fortune calculates as $102 billion in excess “profit”). The size of this portfolio is falling slowly. The Fed should generate at least $30 billion in excess profits in 2012.

Treasury received $15 billion in fees for insuring money market balances and the $150 billion in the mortgage backed bonds it owns. And the FDIC made $8 billion between the increased fees on insured deposits and what it has paid out.

Fortune said that it was not the bailout that was bad, but the excesses of the financial system. Looked at objectively, this is obvious.
One reason for this success is that government has only had to make good on a fraction of its guaranteed loans. The Treasury also had advantageous deals with the banks that were profitable.

In the end, the taxpayers will end up whole or ahead. But the success of the bailout is that it prevented a depression-like situation like we had in 1929. It rescued GM and Chrysler and allowed Ford to survive because it saved the suppliers of the auto companies. It set up a situation where confidence in the banking system and money markets came back and where we could address the problems of our economy.

These are the facts. The rest is propaganda. As Sun Tzu said in The Art of War: “He who does not understand himself or his enemy is doomed to fall.” To understand how to prevent these problems from occurring in the future, we need to know what has been successful. The fear is that politicians and others will believe the lies they are telling others. 

That is a roadmap to disaster. For if we do not see what causes problems and what works, what have we learned?

Bob Chernow is a Milwaukee businessman, a former River Hills Trustee and the former chair of the Regional Telecommunications Commission, the North Shore Cable Commission and the Milwaukee River South Rivershed Commission.

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