Saturday, October 4, 2008

A Mighty Brief History of Bailouts

The forgotten bailout of my post of Sept 30th  is just the most recent in a long line of government interventions.

Here are the three largest bailouts of the past,  (financial figures from a related Wall Street Journal article), and it's easy to see a pattern: they work.

At least they do if done early, with substantial support. They don't seem to fail even when large - look at the incredible credit extended by the RTC - but they do need to happen quickly enough to restore confidence.

-       The S&L Crisis

It cost $124 billion, but an FDIC historian notes, “Perhaps a measure of the Resolution Trust Corporation’s success is that little more than a decade after it closed, this agency that provoked so much debate is now largely forgotten.” 


-       Mortgage defaults of the Great Depression

By 1933, a thousand Americans a day were losing their homes to the bank. Creation of the Home Owners’ Loan Corporation handled 1.9 million applicants, about half of whom had monthly incomes below $150.

 One in ten Americans eventually secured aid from the agency, and since there was no secondary market for securitized mortgages, the agency had to hold the loans for the full terms.

 When it closed in 1951, 80% of borrowers had paid off their loans on time or early, and it even earned a small profit.

 Economist Alan Blinder has cited it as a model to be considered today.


-       The Panic of 1792

When the federal government assumed obligations that states owed from the Revolutionary War, it added $18 million to a domestic debt of $65 million, held in debt securities attractive to speculators. 

One speculator in particular cornered the market on government 6% bonds, so-called Sixes, and then prompted a selling frenzy that led to a 25% drop in value. 

Working without a historical blueprint, Alexander Hamilton engineered an innovate response. The Treasury borrowed money from banks and used to buy the bonds, lifting the market price. He also told banks to accept the bonds as collateral for loans, with the government guaranteeing their worth.

 The financial system stabilized quickly, and not a single bank faired for fifteen years, a remarkable outcome for such an unproven strategy, says economic historian Robert Wright. He named his son Alexander Hamilton Was Wright.


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