Bailout Nation Summary

Summary

Bailout Nation is split into five different sections. The first of these sections is "A Brief History of Bailouts". "The federal government's involvement in companies in the nineteenth century was more as an incubator than a rescuer" (p. 10). There wasn't much venture capital funding then. Railroad and telegraph firms were given easements and rights of passage to facilitate the government's desire to expand into the West. Eminent Domain was also used to purchase properties for the benefit of companies such as mining, railroads, and telegraph firms. These two points were learned in class and have come out in this book. Within these examples, the government's cash outlays were modest.

In these earlier time the government, rather than betting on any single company, found it best to jump start an industry or sector and then let competition take place leaving the best companies standing. The government let these companies follow their own natural life cycle by the mechanics of the free market. The companies that went bust left behind valuable infrastructure for the remaining companies to build upon.

The foundation for the modern bailouts was laid in the early twentieth century, when in 1913, the Federal Reserve System was created. This has major implications down the road. The Federal Reserve System originally was given modest monetary and fiscal powers. Eventually, these powers were expanded dramatically.

During the years of the Great Depression and the World Wars the United States government engaged in a series of economic stimuli. The United States pushed for certain industries to be built up for national defense. Some of the industries included: munitions, steel, and rubber. After World War II, the United States entered a long period of economic expansion.

The Lockheed bailout was the first public bailout of a major single corporation. The rescue of Lockheed in 1971 was the first time the United States bailed out an industrial firm whose own financial negligence had driven it to the edge of extinction. This became the blueprint for future bailouts over the next half century (p. 28). "The emergency loan package for Lockheed Aircraft was highly contested in Congress" (p. 35). The term "corporate welfare" was coined by Wisconsin Senator William Proxmire. This was all too true.

Penn Central Railroad, the nation's largest railroad, declared bankruptcy in 1970. Congress provided loan guarantees to Penn Central's creditors and spent money in direct federal operating subsidies for Conrail. So Penn Central was bailed out. "if Lockheed was the governments' first sip of bailout elixir, Penn Central was a big gulp that opened the floodgates for the bailout binge that was about to come" (p. 38). This was the beginning of what seemed to be a line of corporations lining up to get money from the government.

Nine years after the Lockheed bailout came the bailout of Chrysler. It was six times more expensive than the Lockheed bailout. The rationale was to save jobs and keep one of the big three automotive corporations going so that it could compete with foreign corporations. Barry Ritholtz brings up an interesting point here in the book "What if Chrysler went bankrupt?" He hypothesizes that the failure of Chrysler might have served as a wakeup call to General Motors, Ford, and the United Auto Works union, resulting in more fuel efficient cars and more sustainable labor contracts. Chrysler's assets may have attracted investors, Korean manufacturers perhaps, and the company may have reemerged as a smarter, slimmer corporation. "It is quite reasonable to conclude that the bailout of Chrysler in 1980 prevented significant market forces from doing their best to reboot the entire U.S. auto sector." (p. 44).

The second section of the book is "The Modern Era of Bailouts". "How the Federal Reserve morphed from a lender of last resort to a guarantor of asset prices is a long and tortured tale."(p. 55). Change came to the Fed in the form of a new Federal Open Market Committee (FOMC) chairman. In 1987 Alan Greenspan took over and broke away from his predecessors' philosophies. Under Greenspan FOMC policy gradually moved toward supporting asset prices.

Greenspan started off his tenure with the market crash of 1987. Initially, 1987 was a good year for the markets. The market then continued to slip until Black Monday (October 19) where the Dow plummeted 22.6 percent (p. 54). When the market opened the next day the central bank added to reserves through open market operations. This created a bad example for Greenspan to live by. Greenspan learned early on in his career that the solution to every problem was to throw money at it. This ultimately leads to bigger problems down the road.

Greenspan focused on asset prices, as stated earlier. In December of 1996 Greenspan gave what is referred to as the "irrational exuberance speech". In this speech he stated:

"But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy." (p. 64)

This is an absurd statement. The speech suggests that Greenspan learned precisely the wrong lesson from the 1987 crash. Market bubbles always destroy capital, ruin speculators, and cause all manner of heartache (p. 66). The 1987 crash was unique, it had an unusual outcome relative to past collapses. "The 1987 crash seemed to be the only crash that was 'contained'" (p. 66). Greenspan completely missed this point. This crash was the rare exception, not the rule.

In the late 1990s the tech-heavy NASDAQ index was dominated by active traders. This started inflating a bubble where stocks were being bought on margin. Greenspan did nothing about this. There are two good reasons why the stock market played a role in bailouts. The first is asset prices. The Greenspan Fed had made repeated forays toward protecting asset prices from significant losses. The central