Tuesday, March 10, 2015

2008 Housing Bubble: The Bailout Bonanza!

Prior to 2008 global economic crisis, American officials assured the public that there was nothing to worry about the state of the economy. This was the message of both Henry Paulson, the US treasury secretary and Ben Bernanke, the chairman of Federal Reserve. The popular financial advice was "Don't panic. Don't stop investing. Don't stop borrowing to buy homes. Spend like you're Paris Hilton. Everything is just fine (p. 38)." But after the advice was proven wrong, these officials instead of losing credibility were even demanding greater power.

And so the demand for greater power was granted. It was believed that bailouts can solve the world's economic troubles. The US government took over Fannie Mae and Freddie Mac, which "held $5 trillion in mortgage liabilities" (ibid.). What came next was the "Bank of America's purchase of Merrill Lynch" (p. 39) with the influence of course of the Fed. And then the US treasury secretary came up with "ten financial institutions to work out a bailout for Lehman Brothers" (ibid.). But the solution did not work out and so the "Lehman Brothers was ultimately allowed to go bankrupt" (ibid.). However, the bailout magic continued. AIG received a total of $125 billion bailout, which the New York Times describes the initial bailout of $85 billion as "'the most radical intervention in private business in the central bank's history'" (p. 40). The government was hailed as the savior of corporations at the expense of the productive sector of the economy, the taxpayers. 

With the exception of the Lehman Brothers, which situation was beyond recovery, the popularized reason why the identified firms were not allowed to go bankrupt was to prevent the domino effect of their collapse upon other firms that would seriously harm the economy. 

In reality, it was the act of bailing out these firms that harm the economy. Allowing them to go bankrupt would result into an opportunity for the economy to recover through market forces. For Thomas Woods, bailing out those firms "discourages rather than encourages capital formation and economic recovery" (p. 41). 

To make the situation more serious, as if the previous bailouts were not sufficient enough to ruin the economy, a bill, "the Emergency Economic Stabilization Act of 2008" was passed. This bill gave the US treasury secretary the authority to buy $700 billion in assets "'at any time'" (p. 42). 

Guide Questions:

1. What does it tell about the current system when those in authority who failed in their public pronouncement were entrusted with greater power rather than losing their credibility?

2. What was the perceived solution to global economic crisis? Briefly explain your personal understanding of this solution.

3. Who were the firms that the US government bailed out? What was the justification for doing so?

4. What do you think would be the long-term impact on global economy of this bailout bonanza? Why?

Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.