The passage into U.S. law on October 3, 2008, of the $700 billion financial-sector rescue plan is the latest in the long history of U.S. government bailouts that go back to the Panic of 1792, when the federal government bailed out the 13 United States, which were overburdened by their debt from the Revolutionary War. This law marked the fourth time in 2008 that the government interceded to prevent the ruin of a private enterprise or the entire financial sector.
In addition to the $700 billion bailout, this article will look at five financial crunches in the past century that necessitated government intervention:
- The Great Depression
- The savings and loan bailout of 1989
- The collapse of Bear Stearns, an investment bank and brokerage firm
- American International Group (AIG), an insurance colossus with global reach
- Freddie Mac and Fannie Mae, two government-backed mortgage lenders
- The 2020 COVID-19 pandemic
- Since 1791, the U.S. government has bailed out both states and banks in times of intense economic crisis, like the Great Depression, and the Savings and Loan Crisis of 1989.
- In 2008, the need for the bailout of the financial behemoths grew out of economic conditions, like the rise of consumer debt from bloated subprime mortgages.
- The 2020 COVID-19 pandemic led to multi-trillion dollar bailouts of both businesses and individuals in America and across the globe.
- U.S. government bailouts have cost upward of trillions of dollars.
The Great Depression
Probably the best-known economic catastrophe in recent history, the Great Depression is the name given to the prolonged period of economic decline and stagnation that followed in the wake of the stock market crash of 1929. With the election to the U.S. presidency of Franklin D. Roosevelt in 1933, a number of historically significant, precedent-setting government bailouts and rescue programs were enacted, which were designed to relieve the economic woes that afflicted the country's people and businesses.
As Roosevelt took the oath of office, the national unemployment rate was nearing 25%. Eventually, countless Americans who had lost their jobs lost their homes as well, and the homeless population of the country, especially in urban areas, grew accordingly. To solve this growing problem, The Home Owners' Loan Corporation was created by the government, one of the principal government bailouts of the Depression-era.
The newly-created government agency purchased defaulted mortgages from banks and refinanced them at lower rates. About one million homeowners benefited from the lower fixed rates on their refinanced mortgages, usually written for a 15-year term, although upwards of two million had applied for help. Because there was no secondary market for packaged mortgages, the government held the mortgages until they were paid off.
A variety of other government-financed programs were created to solve the severe national economic distress, which by 1933 had affected almost every sector of the economy. While these federal initiatives were not bailouts, strictly speaking, they provided the money and government support to create tens of thousands of new jobs, principally in public works. Some of the projects accomplished under the government programs were as follows:
- The Hoover Dam was built.
- New post office buildings were constructed around the country.
- Writers were put to work writing state guidebooks.
- Visual artists were employed to paint murals in the new post offices.
- Old roads and bridges were repaired; new roads and bridges were built where needed.
- Farmers received government price supports and subsidies for their produce and livestock.
With a steady income, the re-employed millions began purchasing again, and the economy began to lurch forward in fits and starts, but it was not yet back to previous levels of vitality. By 1939, as World War II began 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 began, and it would culminate in the post-war boom of the 1950s.
The Savings and Loan Bailout of 1989
America's savings and loan institutions (S&Ls), originally created to provide mortgage loans to prospective homeowners, were a nationwide group of conservative, fiscally responsible lenders that helped spur the housing boom that followed the end of World War II. The S&Ls usually paid a slightly higher interest rate on deposits than banks and offered premiums and gifts to attract depositor dollars away from banks, the more traditional repositories of cash.
Flush with funds, numerous savings and loan institutions ventured into commercial real estate. Government regulatory restraints on S&L lending policies were lax. Many of the S&L investments were ill-advised and went sour.
Adding to the developing woes of the nation's S&Ls, the Federal Reserve raised interest rates, and the S&Ls had to pay more interest on deposits than their return on the fixed-rate, lower-interest loans they held.
As a result, approximately half of America's S&Ls, more than 1,600, failed from 1986 through 1995. Total loan defaults ran into the billions of dollars. Additional billions in federally-insured deposits had to be covered by the government. To address the crisis, and the nationwide economic damage it was causing, Congress enacted the Financial Institutions Reform, Recovery and Enforcement Act of 1989, pumping some $293.3 billion into the floundering industry, one of the most costly and extensive government bailouts of all time.
Bank Rescue of 2008, or the Great Recession
Officially called the Emergency Economic Stabilization Act of 2008, this bailout bill surpassed any previous government bailout by hundreds of billions of dollars. The principal mandate of the legislation was to authorize the U.S. Treasury to buy risky and nonperforming debt from various lending institutions. These debts included:
- auto loans
- college loans
- an ambiguous "other" in the bill, which allows for broad interpretation
Part of the bill authorized a cash infusion of $250 billion into the banking system to facilitate and encourage bank-to-bank loans and other types of lending. With the Treasury's purchase of a bank's or mortgage lender's bad debt, the resulting cash infusion restored liquidity—and confidence—to the banking system. The economy depends heavily on lending to finance many expenditures of the business community, including:
- the purchase of critical goods and services, supplies and commodities
- new hiring
- advertising and marketing
- research and development
- numerous other purchases necessary for the smooth functioning of a business
Funding for the rescue plan came from a variety of sources. The U.S. "borrowed" some of the money by issuing Treasury bonds and bills with short-, mid- and long-term maturities. The Treasury also printed additional currency, in an amount not yet determined, to help cover costs. When this occurred, the news of the passage of the rescue bill did boost consumer confidence—an individual's propensity to spend—and thus further stimulate the economy.
The bailouts of 2008 were also politically unpopular, with many critics insisting that government should not intercede in the dynamics of a free market.
Founded in 1923, Bear Stearns flourished through the stock market crash of 1929 and the Great Depression. Yet the subprime mortgage disaster of 2007-2008 caused the giant investment bank and brokerage firm, with billions of dollars in assets, to collapse. In April of 2008, the U.S. government, through the Federal Reserve Bank of New York, rescued Bear Stearns by lending $29 billion to JPMorgan Chase to buy the financially troubled firm.
JPMorgan Chase, another huge financial services firms specializing in banking, investments, and insurance, among other areas, bought Bear Stearns at about $10 per share. The 52-week high of Bear Stearns stock was a lofty $133.20, and so the rock-bottom sale price represented a huge loss for shareholders.
Nevertheless, both former Treasury Secretary Henry Paulson and ex-Fed Chairman Ben Bernanke defended the sale, predicting devastating damage to the U.S. economy if the firm—one of the world's largest securities companies—were allowed to go bankrupt.
Fannie Mae and Freddie Mac
In the late summer of 2008, the U.S. government committed up to $200 billion to save these two giant mortgage lenders from collapse. The federal government seized control of these private, yet government-sponsored, enterprises and guaranteed $100 billion in cash credits to each of them to prevent their bankruptcies.
Freddie Mac and Fannie Mae were also victims of the subprime mortgage disasters. When Fannie Mae became a private enterprise in 1968, its charter permitted it to sell shares to public investors, who assumed that it had government backing. Fannie Mae was, therefore, able to borrow money at very favorable rates only slightly higher than the rate afforded U.S. Treasury debt.
Freddie Mac, created in 1970 to market mortgages offered by federal savings and loan institutions, was also eventually permitted to sell shares to the public in an arrangement with the government similar to that of Fannie Mae.
What brought down both these giants were mortgage loans to unqualified borrowers who secured inexpensive credit with minimal oversight by the lenders and, in too many cases, without income verification. When these loans became delinquent or defaulted, Fannie and Freddie sank deeper into financial trouble, and eventually, the government had to bail them out.
The American International Group (AIG)
In mid-September 2008, the U.S. government took control of American International Group (AIG), one of the world's largest insurance companies. Private lenders declined to loan money to the financially troubled firm, prompting the federal government to take control of the company and guarantee to loan it up to $85 billion.
In return for the two-year, interest-bearing loan, the government took a 79.9% equity position in AIG. Collateralized by AIG assets—principally the company's hefty insurance revenues—the government's risk was somewhat diminished. Provisions of the loan also require AIG to sell several of its marginal or unprofitable businesses, boosting the company's cash position and divesting it of some nonperforming debt.
The federal seizure of AIG represented the first time ever that a private insurance firm was controlled by the government. This historic "first" was implemented when the Federal Reserve invoked a provision of the Federal Reserve Act, which authorizes loans to non-banks in a certain specified emergency or unusual situations. The chief executive officer (CEO) of AIG was forced to leave the company under the conditions of the bailout.
The COVID-19 Pandemic
Perhaps the most staggering government bailout has been the response to the COVID-19 pandemic that swept the globe in early 2020. As a result of this deadly new disease, hospitals were overwhelmed and citizens around the world urged to stay at home. This led to a drastic drop in consumption as well as a spike in unemployment not seen since the Great Depression. As a result, the government coordinated a series of phased bailouts of large and small businesses, extended unemployment benefits, and gave every working family in America a cash handout of $1,200 per adult and $500 per dependent child - America's first taste of universal basic income (UBI). To date, nearly $4 trillion has been deployed to keep the economy running in the face of the pandemic.
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; by 2008, the U.S. had become over-extended, with trillions of dollars in debt, that it may not have the resources to fund such 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 economy of the U.S. But with new regulatory legislation and more vigilant oversight, bailouts of the dollar magnitude that characterized the rescues of 2008 may be less necessary - unless of course, some exogenous shock like a pandemic strikes again.