Has anything good come from $3 trillion worth of bailouts over the last 18 months? To be fair, probably. After Lehman Brothers failed in September 2008 and other Wall Street firms began to founder, urgent government intervention forestalled a deeper financial panic and perhaps even a depression. Instead of talking about a recovery today, we could be facing steep double-digit unemployment and many more months of misery.
But the Year of the Bailout also entailed some disturbing moments, and there may still be unhappy consequences. Here's my list of the worst bailouts:
AIG. Did the Federal Reserve know what it was getting into on Sept. 16, 2008? That's the day AIG would have collapsed if the Fed hadn't issued $85 billion in credit to the huge insurance company in exchange for a 79.9 percent ownership stake. The problem wasn't AIG's insurance units, which constitute most of the firm, but an internal hedge fund, AIG Financial Products, that was basically backing huge gambles with solid insurance assets. When the hedge fund bet wrong on billions in mortgage-backed securities, it imperiled the entire company.
The Fed's intervention may have prevented deep losses throughout the banking system, but it also committed the government to a tawdry, open-ended bailout that's easily the single-biggest corporate rescue in U.S. history. The March 2009 revelation that AIG paid $165 million in bonuses to executives at the same Financial Products division that sank the firm became the hottest flash point in the Year of the Bailout and the darkest stain on bailout architects like Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke. Barry Ritholtz, author of Bailout Nation, contends that the government could have taken over the Financial Products division and treated it as a failed bank, imposing losses on every firm that did business with the unit. "You're supposed to suffer pain and agony when you put money into a company that's as corrupt as that AIG hedge fund," Ritholtz says. The insurance units, he argues, could have been spun off as a new stand-alone company, freed from the albatross of Financial Products.
Bernanke has argued that since AIG wasn't a bank, the federal government lacked a legal and practical mechanism for taking over and dismantling the company. That's why the Obama administration wants Congress to grant the Fed new powers to take over "systemically significant" institutions like AIG when they fail. Meanwhile, the AIG bailout could wind on for another three or four years, and there's a good chance taxpayers will never get all their money back.
Citigroup (NYSE:C). When other banks become insolvent, the Federal Deposit Insurance Corp. swoops in, fires management, zeroes out the stock, pays bondholders a portion of their investment, and either sells off the bank in pieces to other banks or runs it until a buyer is found. But not Citigroup. This lumbering giant would have collapsed on its own, but instead of a takeover, Citigroup got $25 billion in bailout funds in October 2008, then another $20 billion three months later. Plus taxpayers are on the hook for a big chunk of $301 billion in mortgage-backed securities and other dodgy assets on Citigroup's books. It could be years before Citigroup is healthy. CEO Vikram Pandit has said that the fazed bank will pay back the taxpayers in full. But there's no deadline, and Pandit himself could be long gone before taxpayers get a dime back.
Bank of America (NYSE:BAC). If this North Carolina-based bank hadn't picked up ailing brokerage firm Merrill Lynch in September 2008, it might be out of the woods by now. But the Merrill acquisition saddled BofA with billions in losses and made CEO Ken Lewis a corporate pariah. One of the most tawdry episodes in the Year of the Bailout was the battle between Lewis, who reportedly wanted to renege on the Merrill acquisition when he learned that the brokerage would post a $28 billion loss for 2008, and Bernanke, who threatened Lewis with the disapprobation of the Fed if he backed out, which basically equates to death by bank examiner. Lewis caved. Then a couple months later he got to explain why Merrill executives earned $3.6 billion in bonuses while taxpayers were providing $45 billion to keep the firm afloat. Go ahead. Scream.
Goldman Sachs (NYSE:GS). Wall Street's toniest firm got $10 billion in TARP money in October 2008, along with eight other big banks that got government checks. Eight months later, Goldman was the first big bank to pay back its bailout money, with interest. Hooray for them. But Goldman also got a stealth bailout that will never be returned to taxpayers, courtesy of AIG. When the feds propped up AIG last fall, that allowed Goldman to ease its way out of nearly $6 billion worth of deals with AIG that could have been worth pennies on the dollar in a normal bankruptcy case. And later, Goldman got almost $14 billion of bailout money that went to AIG's trading partners, effectively redeeming Goldman's trading bets with AIG at 100 percent of their face value.
Other banks got a 100 percent redemption out of AIG too, but Goldman got the most. And the fact that Henry Paulson, who was treasury secretary during the first four months of the meltdown, had come straight from a stint as CEO of Goldman Sachs raised the awful prospect that billions in taxpayer money was going to favored Wall Street fat cats. Nobody has ever offered a convincing explanation for the delicate treatment Goldman received, which fuels the worst kind of speculation. Please, say it ain't so.
Bear Stearns. Nobody knew how momentous it was at the time, but the $30 billion deal in March 2008 to keep Bear from completely imploding set the stage for every bailout that followed—and some other disasters as well. Bear was one of the biggest players in the market for mortgage-backed securities, and it fell first when that market began to crumble. The Fed brokered a deal in which JPMorgan bought most of the firm for $1.2 billion, a fraction of Bear's former value, with the Fed taking on $29 billion worth of toxic securities nobody else would touch. The bailout helped calm markets at the time—partly because it created the expectation that the government would rescue any other Wall Street firm that got into trouble.
That led Lehman Brothers to turn down financing offers from Warren Buffett and others when it needed cash, presumably because the firm felt it could hold out for a better deal—from the government, if necessary. When the feds let Lehman fail in September 2008, the chaos that followed partly stemmed from deep confusion over who deserved a bailout and who deserved a bullet. In retrospect, it's plausible that if the feds had let Bear Stearns fail outright, they could have done a better job of forcing Wall Street to work out its own problems—while saving taxpayers several hundred billion dollars. Of course, we'll never know. You only get one chance to get an epic bailout right.