When the Lehman Brothers crisis was at its height, the debate over government intervention in the corporate sector raged like a blast furnace. On the one side were those who bellowed that taxpayer dollars had no place bailing out private banks that hadn't the wherewithal to behave responsibly in the first place. On the other were proponents of the "too big to fail" theory. According to them, not intervening in the capital markets would have engendered a disaster far greater than the death of a couple dozen private corporations. A complete loss of faith in the financial system was at stake. Bolstering confidence - at any price - was, in their minds, the lesser of the two evils. (To learn more, see our Case Study: The Collapse Of Lehman Brothers.)
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Once They Start Keeping Stats…
The truth is, however, that one doesn't have to sift so far through the sands of history to find that this same debate has been hashed out numerous times in a host of different lands and locales over just the last few decades. Bailouts are not an extraordinary exercise in times of financial strife. And, for better or worse, they're now becoming a regular feature of the global financial landscape. So much so, in fact, that the World Bank determined in 2002 that country bailouts cost an average of 13% of GDP. When they start keeping stats on these things, you know there's more to come.
In Japan, the initial cost was slightly less. In 1990, asset bubbles in the real estate and equity markets finally popped, sending both markets reeling from heights they've yet to reach again. However, the government waited until 1996 to take action, injecting $100 billion at that time and another $500 billion in 1998. A total of 12% of GDP was expended with little to no result.
Today, the Japanese economy is still coping with a twenty-year deflationary plague, equity markets are more than 70% below their 1989 highs and real estate prices are far from regaining their former levels. (For more, see Market Crashes: The Asian Crisis.)
No Meatball Strategy
At about the same time, The Government of Sweden was having a little better luck. Sweden's government stepped in to bail out a failing banking industry in much the same way the U.S. Treasury and Federal Reserve did in 2008-2009. They took an equity interest in the banks, assumed bad loans and essentially wiped out existing shareholders.
When the dust settled and the banks were back on their feet, the government repackaged and sold their equity stakes back to the market for a profit. The banks were again solvent, taxpayers won and the story ended happily. A few legislative changes were implemented to keep the public safe and shareholders more secure, and then Sweden closed the book on its 1991 bank bailout.
Closer to Home…
But one need look no further than Greenwich, Connecticut to find a more recent story of corporate malfeasance and subsequent government intervention. The 1998 failure of Long Term Capital Management Corp. (LTCM) - a hedge fund run by a prestigious array of Wall Street heavyweights and Nobel Prize winners - brought the U.S. Fed into the picture in an indirect, yet heavy-handed manner.
Then Fed Chairman, Alan Greenspan, organized a consortium of Wall Street banks and brokers to bail out the failing company and cover its massively leveraged trade book. The rationale was that a savior was needed to avoid a potential chain reaction of trade-covering that would have brought down several big financials then doing business with LTCM.
LTCM wound down two years later with little effect to the broader economy. Several careers were derailed, however, including that of former Goldman Sachs chief, Jon Corzine, who was expected by many to succeed Greenspan at the Fed. (To learn more, check out Massive Hedge Fund Failures.)
Bailouts Here To Stay
There's no doubt that the latest bailout of the financial sector garnered greater media attention and focused the debate to a greater degree than any other such occurrence before or since. Certainly the scale of intervention was greater than anything previously experienced - and the accompanying drop in equity markets more severe. It's not surprising that such extremes would heat up the debate surrounding the government's role in times of crisis. But now that the recovery is underway and equities are surging, who wants to argue? (To learn more, see Top 6 U.S. Government Financial Bailouts.)
Still feeling uninformed? Read this week's financial news highlights in Water Cooler Finance: Buffett's Armed and Greece Keeps Falling.