Bailout fever

During the recent financial crisis, former Treasury Secretary Timothy Geithner was dubbed “the bailout king” by a prominent New York Times columnist. Now he has released a new book, Stress Test, that tells his side of the story. He doesn’t deny he was the biggest cheerleader for the $700 billion TARP legislation and the string of taxpayer-funded bailouts. Far from it. According to Geithner, history has proven him right.

In addition to saying the bailouts saved the financial system, Geithner has been making several other claims on his book tour. The first is that bailouts are inevitable. Trying to end them is “like Moby-Dick for economists or regulators,” he says. “It’s not just quixotic, it’s misguided.” Geithner also says the bailouts have proven to be a moneymaker for American taxpayers, earning $32 billion from TARP alone so far, and perhaps as much as $100 billion in the end.

I do think our former Treasury secretary is right about one thing: Bailouts will continue in some form. If regulators are worried that failure of a key bank will jeopardize the financial system, they’ll figure out a way to bail out the bank. But this doesn’t mean, as Geithner seems to suggest, we should stop worrying about bailouts. Although Captain Ahab might have been better off letting the whale go, we aren’t. Even if we can’t end bailouts, we can make them as rare as possible. Perhaps we should force a few of the largest and most unwieldy banks to downsize a bit. We certainly should tinker with our bankruptcy laws (a pet project of mine) so that regulators will be more willing to allow big banks to fail in the future.

What about all that money the government is raking in? Even apart from the oddity of treating bailouts as a growth opportunity—would lots more bailouts have been even better?—if the goal was earning money for taxpayers, the government should have insisted on much tougher terms. Any ordinary lender that lent money to the big banks at the height of the crisis would have charged a very steep interest rate. From this perspective, the government should have made a lot more from its bailout loans than it did.

But the real problem is the insidious costs of bailouts. Because creditors of the biggest banks still expect to be protected if the banks fail, Citigroup or JPMorgan Chase can raise money much more cheaply than small and middle-sized banks, making it hard for the small and middle-sized banks to compete. Ask any community banker you know if he or she thinks the bailouts have made us all better off. And don’t get me started on Fannie Mae and Freddie Mac, the government mortgage giants. If they had been shut down after their collapse, as they should have been, Fannie and Freddie wouldn’t have paid back their bailouts, but the housing markets would be much healthier and less prone to politicization.

If it weren’t for the massive bailouts—if regulators had allowed the investment bank Bear Stearns to fail at the outset of the crisis, for instance—the U.S. economy surely would have recovered from the Great Recession much faster than it has. One economist recently estimated that the unusually slow recovery has cost between $5 trillion and $7 trillion in lost Gross Domestic Product since 2008. The bailouts aren’t the only reason for the slow recovery of course, but they deserve a large dollop of the blame.

A $32 billion profit sounds like a really nice outcome. But there’s a lot less to brag about if we compare it to a $5 trillion to $7 trillion cost.

—David Skeel teaches corporate law at the University of Pennsylvania