by Chidem Kurdas
After all that’s been said and written about financial crises, it is rare to come across useful insights. Financing Failure. A Century of Bailouts by Vern McKinley documents a major continuity with past policy making. He shows that policies intended to prop up failing companies are nothing new—the same basic pattern has recurred time and again.
But there is one notable change: the bailouts grew ever larger and the agencies concerned with them ever more numerous. Anyone thinking about recent crises and future prospects would do well to keep these points in mind.
The book draws parallels through the decades. Some examples go from the early 20th century right through the 2008 crisis. Thus Continental Illinois National Bank was failing in the 1930s , mainly because of bad loans to utilities in the Chicago area. In 1933 the Reconstruction Finance Corp., a federal entity created by Herbert Hoover, bailed out Continental Illinois with $50 million. The bank failed again in the 1980s and was bailed again, this time with $4 billion under the FDIC’s special powers. Then Bank of America acquired the remains of Continental Illinois. You will recall the $45 billion federal support for Bank of America after its purchase of the failing Merrill Lynch four years ago.
Mr. McKinley, a policy expert and research fellow at the Independent Institute, remarks: “One has to wonder what form the firm will take when it is bailed out during the next financial crisis later this century.”
Chapters on the 1930s and 1980s form the core of the book. Having presented the history, the author connects the dots. Politicians and regulators presume all is under control; when a crisis appears they panic and rush to take some sort of action. Thereby they enact the logical fallacy immortalized in the British sitcom, Yes, Prime Minister: “We must do something; this is something; therefore we must do this.”
So after every financial turbulence Washington comes up with another raft of interventions, bureaucracies and committees to prevent crises—the latter range from the Federal Reserve, founded in 1913, to the Working Group on Financial Markets, set up in 1988, and the Financial Stability Oversight Council, created in 2010. The intention is to stabilize the system but the long-term consequences are less benign.
Mr. McKinley writes: “the number of agencies deploying bailouts multiplied, the safety net became bigger and bigger, and the primary beneficiaries were soon concentrated among the largest of financial institutions, who came to rely on and demand this ready source of government backstopping…” That distorts investment decisions and risk taking, eventually fueling another crisis. The cycle repeats. Another notch is added to the trend for more government backing.
What to do? Shut down failing banks rather than buttressing them, the book concludes. That is much easier said than done; Mr. McKinley does not delve into the political realities that encourage bailouts. Nevertheless, everybody with an interest in financial regulation should read his account of how the new TBTF is the old TBTF with a few added bells and whistles.