Lawmakers are pledging to end bailouts in the financial reform
bill that the Senate is considering now. But many experts say bank
bailouts can and will occur again.
"Orderly liquidation." The words appear prominently in financial
reform bills to overhaul the way the US government will regulate
America's financial system in the aftermath of a near-meltdown in
The idea is that if a large firm gets into trouble in the future,
it can't expect any generous taxpayer bailouts, as happened at
American International Group (AIG) and other firms. Rather, if a
large bank takes big risks that go awry, regulators will preside
over its dismemberment with steely resolve.
That, at least, is the simple message lawmakers say they want to
send with legislation that's moving into its second week of Senate
President Obama, too, has been pledging an end to bailouts.
"That's what this reform does," he said recently of the Senate bill.
But regulating the vast financial system is anything but simple,
and many experts say bank bailouts can and will occur again, even if
Mr. Obama ends up signing a reform bill by midyear.
A basic problem lies in that phrase, "orderly liquidation." In
the heat of a financial crisis, that's something very hard to do
with a large and interconnected financial firm on the brink of
Orderly liquidation is exactly what did not occur in 2008. During
the crisis, most tottering firms - from sprawling Citigroup to
insurance giant AIG - received some form of government backing.
Then, when Lehman Brothers didn't get a government bailout, credit
markets quickly spiraled down toward what could have become a broad
and catastrophic collapse. To restore stability, Congress held its
nose and created a $700 billion rescue fund.
For regulators and Congress, propping up the economy trumped a
distaste for bailouts.
"In a crisis, they'll do the same thing again," predicts Peter
Nigro, a finance expert at Bryant University in Smithfield, R.I.
No outright ban on bailouts
The bills in the House (already passed) and Senate (in progress)
include tough language designed to make bailouts both less common
and less generous in the future.
But some critics of the legislation say it will fail to end
bailouts, and that this is a bad thing. The real problem during
2008, they say, was not that Lehman wasn't rescued but that
investors had come to expect government aid rather than insisting
upon caution and discipline in financial activities. The proposed
bills will perpetuate this problem, these critics warn.
At the other end of the spectrum, some economists say the
opposite: The law may succeed at preventing bailouts - and that this
is a bad thing. You don't want to tie regulators' hands in a crisis
or possibly make a crisis worse by moving to dismantle large firms.
A middle view is that the legislation strikes a reasonable
balance. These financial experts say the bill puts investors in
failing firms on notice that they will bear losses when a firm gets
in trouble, while also giving regulators the flexibility to contain
any economic ripple effects from a firm's failure.
"A lot of the discussion has been overly simplistic," says Dean
Baker of the liberal Center for Economic Policy and Research in
Washington. For all the talk about the need to end bailouts, he
says, the bills still give "relatively open-ended authority" to
government officials in a crisis. "I'm not upset that they have that
option," he says.
In the 2008 crisis, the recession might have become much worse
without the safety net provided by that $700 billion Troubled Asset
Relief Program and extraordinary Federal Reserve lending activities,
In this light, the question of "bailouts" versus "liquidation" is
not just one of fairness to taxpayers. The larger question - the
issue that's -fueling the drive for financial reform - is how to
protect the economy from financial crises. …