The U.S. government has a long history of leading economic bailouts. The first major intervention occurred during the Panic of 1792, when Treasury Secretary Alexander Hamilton authorized purchases to prevent the collapse of the securities market. When private enterprises are in need of rescue, the government is often ready to prevent their ruin. In this article, we look at six instances over the past century that have necessitated government intervention:
- The Great Depression
- The Savings and Loan Crisis
- The conservatorship of Fannie Mae and Freddie Mac
- The collapse of Bear Stearns
- The rescue of American International Group (AIG)
- The COVID-19 pandemic
- The Panic of 1792 was the first time the federal government intervened to prop up the markets. During that crisis, Treasury Secretary Alexander Hamilton authorized purchases to prevent the collapse of the securities market.
- During the Great Depression, a government program to buy and refinance defaulted mortgages kept 1 million families in their homes.
- The Savings & Loan crisis cost the government $160 billion (in 1990 dollars) to clean up.
- In response to the COVID-19 pandemic, the government authorized more than $2 trillion in assistance, including providing stimulus checks of $1,200 for every adult and $500 for every child.
The Great Depression
The Great Depression is the name given to the prolonged economic decline and stagnation precipitated by the stock market crash of 1929. Following the election of President Franklin D. Roosevelt in 1933, the government enacted a number of precedent-setting rescue programs designed to provide relief to the nation's people and businesses.
When Roosevelt took office, the unemployment rate neared 25%. Countless Americans who lost their jobs also lost their homes. The homeless population grew, especially in urban areas. To keep people in their homes, the government created the Home Owners' Loan Corporation, which bought defaulted mortgages from banks and refinanced them at lower rates. The program helped one million families benefit from lower rates on refinanced mortgages. Because there was no secondary market, the government held the mortgages until they were paid off.
The government created a number of other programs to help the nation weather the Great Depression. While these initiatives were not bailouts, strictly speaking, they provided money and support to create tens of thousands of new jobs, principally in public works. Some of these projects included:
- Building the Hoover Dam
- Repairing roads and bridges and building new ones where needed
- Constructing new post office buildings around the country
- Hiring artists to paint murals at the new post offices
- Hiring writers to author state guidebooks
- Providing price supports and subsidies for farmers
Armed with a steady income, millions of re-employed workers began purchasing again and the economy recovered slowly. By 1939, as World War II broke out in Europe, the Great Depression was beginning to loosen its grip on the economy. When the U.S. entered the war after the bombing of Pearl Harbor in 1941, the great economic recovery was already underway, and it would culminate in the post-war boom of the 1950s.
The Savings and Loan Bailout of 1989
Savings & Loan institutions (S&Ls) were originally created to provide mortgages to homeowners and helped spur the housing boom that followed the end of World War II. S&Ls usually paid a higher interest rate on deposits than commercial banks and offered premiums and gifts to attract depositors.
Flush with funds, numerous S&Ls ventured into risky and ill-advised commercial real estate ventures. In addition, rising interest rates meant S&Ls were paying more interest on deposits than what they collected on fixed-rate loans. Many were insolvent by the early 1980s, but customers kept banking with them because they knew their deposits were insured. In addition, regulators allowed zombie banks to continue operating in hopes they would eventually return to profitability.
By 1986, approximately 1,000 S&Ls that were still in operation were insolvent or nearly insolvent. Loan defaults ran into the billions, and billions more were spent to cover federally insured deposits. Congress took several measures to address the crisis, such as passing the Financial Institutions Reform, Recovery and Enforcement Act of 1989 and creating the Resolution Trust Corporation to sell off assets. Between 1986 and 1995, the government spent an estimated $160 billion (in 1990 dollars) cleaning up the savings and loan mess.
Bank Rescue of 2008, or the Great Recession
The 2007-08 Financial Crisis resulted in an unprecedented federal intervention to rescue banks and restore confidence to finance sector. The chief culprit in the crisis was the implosion of mortgage-backed securities (MBS) and the collapse of the housing market that threatened many companies with insolvency. In the early days of the crisis, no one knew which companies were holding toxic assets and who would be next to falter. Lack of trust spread, with market participants unwilling to take on counterparty risk. As a result, companies were prevented from accessing credit to meet their liquidity needs.
To address the crisis, Congress passed the Emergency Economic Stabilization Act of 2008. The act created the Troubled Asset Relief Program (TARP), which authorized the U.S. Department of the Treasury to buy up to $700 billion in toxic assets from companies, which could then replenish their balance sheets with safer assets.
The Treasury Department was also authorized to buy up to $250 billion in bank shares, which would provide much needed capital to financial institutions. It bought $20 billion in shares each from Bank of America (BAC) and Citigroup (C). The Treasury Department later sold those shares back for a profit. In total, the government provided $245.1 billion in TARP assistance to banks and recouped $275.6 billion, for an investment gain of $30.5 billion.
Fannie Mae and Freddie Mac
The implosion of the housing market also brought trouble to Fannie Mae and Freddie Mac, two government-sponsored enterprises charged with promoting homeownership by providing liquidity to the housing market. Fannie and Freddie play a vital role in the housing market by purchasing mortgages from lenders and guaranteeing loans. Congress authorized the creation of Fannie Mae during the Great Depression and Freddie Mac in 1970.
In 2008, at the height of the financial crisis, Fannie and Freddie held obligations on $1.2 trillion in bonds and $3.7 trillion in mortgage-backed securities. A deterioration in their finances meant neither could service their obligations. This forced the Federal Housing Finance Agency (FHFA), which regulates Fannie and Freddie, to put both into conservatorship.
To keep both solvent, the Treasury Department provided $119.8 billion to Fannie Mae and $71.7 billion to Freddie Mac in exchange for senior preferred stock. This required Fannie and Freddie to pay dividends to the government ahead of all other shareholders. As of 2018, Fannie Mae has paid $176 billion in dividends to the Treasury Department, while Freddie Mac has paid $117 billion.
The lifeline extended by the Treasury Department gave both time to clean up their finances. The two reported losses between 2007 and 2011, returning to profitability in 2012. In 2018, Fannie Mae reported $16 billion in earnings, while Freddie Mac reported $9.2 billion.
Mortgage-related losses took their toll on Bear Stearns, prompting the Federal Reserve to step in to prevent its collapse in 2008. Bear Stearns—like Bank of America, Citigroup and AIG—was deemed too big to fail. Its collapse, it was feared, posed systemic risks to the market. The Federal Reserve brokered a merger between Bear Stearns and JPMorgan Chase. To facilitate the deal, the first Fed provided a $12.9 billion bridge loan, which was repaid with interest.
The Fed then lent $28.82 billion to a Delaware corporation created to buy financial assets from Bear Stearns. This corporation, Maiden Lane I, then repaid the Fed interest and principal using proceeds from the sale of those assets. By November 2012, Maiden Lane I had repaid the principal and $765 million in accrued interest to the Fed. Maiden Lane I still held $1.7 billion in assets as of December 2014, which would generate gains for the Fed once they are sold or mature.
The American International Group (AIG)
During the financial crisis, the government took control of American International Group (AIG) to prevent the fifth-largest insurer in the world from going bankrupt. AIG had faced steep derivative losses, and the Federal Reserve was worried its failure could severely disrupt financial markets. The Federal Reserve and Treasury Department provided $141.8 billion in assistance in exchange for receiving 92% ownership of the company.
The government earned a $23.1 billion profit as a result of the bailout. AIG paid $18.1 billion in interest, dividends and capital gains to the Fed. In addition, the Treasury netted $17.55 billion in capital gains. However, about $12.5 billion in assistance provided under TARP was not recovered, resulting in a net gain of $23.1 billion for the government.
The COVID-19 Pandemic
Perhaps the most staggering example of a government bailout has been the response to the COVID-19 pandemic, which led to a severe contraction in economic activity and employment as people all over the world stayed home to curtail the spread of the disease. On March 27, 2020, President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which provided more than $2 trillion in assistance. This included stimulus check payments of $1,200 per adult and $500 per dependent child.
Other measures included the Paycheck Protection Program, which funneled more than $500 billion to companies through the Small Business Administration to keep workers on the payrolls. Meanwhile, the Federal Reserve provided liquidity to financial markets by expanding its balance sheet by $3 trillion.
The Bottom Line
Can the U.S. government continue to bail out troubled businesses such as Bear Stearns and AIG, and government-backed institutions such as Freddie Mac and Fannie Mae? Many economists say no. The U.S. has run up trillions of dollars in debt and may not have the resources to fund huge bailouts in the future.
Economics can be unpredictable, and no one can say what the future will bring in an ever-changing world in which the economies of emerging nations—especially China and India—can have major impacts on the U.S. But with new regulatory legislation and more vigilant oversight, bailouts of the magnitude that characterized the rescues of 2008 may be less necessary, unless of course some exogenous shock like a pandemic strikes again.