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The Real Price of Life in Bailout Nation

Blogger and quant researcher Barry Ritholtz

In his just-published book, Bailout Nation, quant
researcher and the popular blogger behind href="">The Big Picture Barry Ritholtz argues
that major players in the U.S. economy have become far too accustomed to
letting the U.S. government pay for their mistakes. The result is moral hazard
run riot — at substantial cost not only to the taxpayer but also to
the competitiveness of the American economy.

In Ritholtz's view, regulators should only help to
keep businesses honest and create the correct incentives, not act to prop up
asset prices nor cover the bets of companies that got it wrong. (Under the
Ritholtz rules, Long Term Capital Management, for one, would have been allowed
to sink.) An economy in which businesses do not have to accept the consequences
of their actions, up to and including failure, Ritholtz says, is bad for

Here Ritholtz discusses why no company or institution should be
considered "too big to fail," who deserves the most blame
for our current predicament, and the long-term consequences of all this
government intervention.

What is the most common misconception about the crisis?

That this was a perfect storm of unexpected and unavoidable
events. Not true. This was the inevitable result of a series of decisions made
by CEOs, bankers, and regulators. A lot of the damage that was done, the actors
did to themselves. Lehman Brothers and Bear Stearns, for example, wanted maximum mortgage exposure and wanted to leverage up to do it. They weren’t
killed by a series of unfortunate events; they committed suicide.

Is there any company or institution that’s too big to

In a moment of panic, it can look that way. But if you calm
down and think about it, why couldn’t, say, href=";col1">AIG,
have been allowed to fail? What made AIG important as a company was the
insurance side, and that part is OK. AIG could have been split between its
insurance operations and what was really a parallel, unregulated, financial
operation. I don’t see any reason at all to bail out the latter,
which has no value and made its own bad bets.

As for href=";col1">Citigroup,
I don’t see why it could not have been told to go through a
structured, organized bankruptcy process — fire the CEO, wipe out the
shareholders, and sell the toxic debt for whatever you can get for it. Then you
have a healthy banking situation again. Similarly for href=";col1">Bank
of America, if you are dumb enough to buy Countrywide and overpay for
Merrill Lynch, why should you be saved? As I see it, [Treasury Secretary] Henry
Paulson and [Federal Reserve Chairman] Ben Bernanke were and are trying to save
the banks, but it is not the banks that need to be saved — it’s
the banking system. There should be no sacred cows. Too big to fail is a

What is the most surprising thing you learned while researching this book?

That Lehman Brothers could have been saved. Warren Buffett
went to Dick Fuld and said, “I’m willing to give you couple
of billion dollars on these terms.” Fuld turned him down, and so
Lehman died. Buffett invested in href=";col1">Goldman
Sachs instead.

Which of the many bailouts you discuss in your book was the most misguided?

Oh, gosh, there are so many. Chrysler in 1980 sort of set
the stage. Then there’s AIG and the way href=";col1">JP
Morgan talked a naive Fed into giving it $29 billion to take Bear Stearns —
that was just horrific. But if I had to pick, I’d say Alan Greenspan’s
bailout of the stock market after the crash of 2000. I know that this is not
what people think of as a typical bailout, but it qualifies. The run-up in
stock prices had been a classic spree, and when you go on a binge, you are
supposed to suffer the hangover. Greenspan would not let that happen. Instead,
the Fed cut rates to historically low levels and then kept them there for
years. The only plausible reason for this is that he was bailing out investors.
And the result, of course, was to create moral hazard, in the form of reckless
speculation. This was the start of all the subsequent trouble.

So how much responsibility do you think Alan Greenspan ultimately bears for
our current mess?

Historically, during the recessions of the ’50s
and ’60s, the Fed brought interest rates down to very low levels for
very brief periods of time — a couple of weeks or months. Greenspan
did something unprecedented, lowering them below 2 percent for three years, and
down to 1 percent for more than a year. This had enormous repercussions: higher
commodity costs, the spiral in home prices, the mad scramble among bond
managers for yield.

Second, the Fed was charged with regulating the banking
industry, and it didn’t. Mortgage companies were allowed to lend to
anybody regardless of ability to repay, and the mortgage shops didn’t
care as long as they could sell [the loans] to Wall Street. So as I see it, the
Fed caused the problem, and then, as the disease was spreading, it allowed the
disease to go untreated.

Who bears more responsibility for the financial crisis, Republicans or

The Republicans controlled Congress from 1994 to 2006 and
the White House from 2000 to 2008. But it was a Democrat, Bill Clinton, who
signed the repeal of the Glass-Steagall Act, which prohibited bank holding
companies from owning other financial firms, and the Commodity Futures
Modernization Act (CFMA), which removed derivatives and credit default swaps
from regulatory oversight. Both parties kept Alan Greenspan at the Fed, and it
was Democrats who passed the Troubled Asset Relief Program (TARP); most
Republicans were against it. So this was a bipartisan snafu, but not a 50-50
one; I’d say 60-40, with Republicans bearing more of the blame
because they had more responsibility. The best way to assess it is that a lot
of the Republican free-market philosophy was made worse by the Democratic
reaction to it, of saying, let’s throw a few hundred billion dollars
at the problem.

You make the case that being bailed out has become an expectation —
one that is harmful to the U.S. in the long term. How can this dynamic be

You have to put the fear of God into bondholders and
corporate executives, so that when they screw up, they know they will have to
pay for it. One good way to start would be to claw back some of the more
outrageous executive compensation packages. It would scare the crap out of
executives in the future if they see some big names have to cough up gains
based on phantom profits. The principle is simple: You cannot expect to book
profits that are ephemeral — practically fraudulent — and
expect to keep the gains. You don’t get to live in a 47-room mansion
in Greenwich when you helped bring about the end of the global financial

Notice how differently the partnership-based institutions
did, like private equity and venture capital firms. They didn’t get
involved in the subprime [lending] insanity, and none of these blew up. Their
risk management approach was different because the partners all bore the
consequences of their own actions — it was not the problem of
shareholders or, ultimately, taxpayers.

What would you do if you were Ben Bernanke right now?

Make sure that lending is performed in a way that borrowers
show that they have the ability to repay the loans they are contracting. I’d
reinstate Glass-Steagall and overturn the CFMA, and reduce the amount of
leverage allowed. Basically, I’d say that depository banks cannot be
casinos; I would make that part of banking a boring, low-risk, low-return

What has been the effect of all these bailouts on ordinary Americans?

Every time there is a foreclosure, that brings down property
values in the neighborhood. At the same time, a lot of people were priced out
during the crazy housing boom. In addition, the deficits that we as a nation
have incurred by these bailouts are enormous; our grandkids are going to be
paying this. And because we’ve used so much money for these bailouts,
our options to do other things — build parks, cut taxes, or whatever —
is being limited.

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