Economic Bailout Causes

The news is slowly emerging with the truth about the causes of the economic bailout.
Numerous major news outlets as well as the the comedy show, Saturday Night Live, are
slowly revealing the underlying causes of the bailout. Will the public examine and digest
what they are telling

us, or will we ignore the causes and go about our merry ways hoping that $700 billion
will ameliorate the causes of the economic bailout mess?
While greed on the part of Wall Street, our financial institutions and those seeking
mortgages and instant housing market wealth is credited with creating the problem and
the subsequent economic bailout, one has to wonder what created the climate of greed
that fueled the crisis. Look no farther than the Congress of the United States. The same
people that invited America to participate in the greed party are now tasked with
implementing the economic bailout.

Can one really blame those that attended the party? Have you ever been to a promotional
event that promises something for free? That type of promotional gimmick always works
and the affairs are always crowded as we seek to get something for nothing. The home
mortgage market became a "something for very little" party as the requirements for
obtaining a mortgage were adjusted, altered, and minimized. Mortgages were made
available to purchasers that might not otherwise have qualified. The seeds of the current
economic bailout were sewn by our government. The government secured the financial
activities of the major mortgage lenders Freddie Mac and Fannie Mae and consequently
loan origination institutions joined in the greed party and collected their commissions by
approving billions of dollars for mortgages that ultimately failed. Simply put the root
causes of the economic bailout fall squarely on our government. They sponsored the
party and now every sensible and responsible American will pay, whether they attended
or not.

Bailout Failure Causes Volatility to Spike

The failure of the $700 billion bailout package in the U.S. House of Representatives
has caused an explosion of fear in the marketplace, as stocks drop dramatically and
investors retreat to the safety of short-term Treasurys.

The VIX, traded on the Chicago Board Options Exchange, was lately at 46.39, ramping
higher as investors build more fear into the marketplace. It reached levels not seen since
October 2002. According to Frederic Ruffy, options strategist at Whatstrading.com, more
than 437,000 S&P 500 index puts have traded, compared with just 200,000 index calls.
“The key is that Washington needs to pass a bailout plan,” writes Len Blum of Westwood
Capital. “As everyone has undoubtedly heard over the past several days, there are many
reasonable bailout proposals. Most of them work – some more efficiently than others.”

Effectiveness of bailouts in the EU

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Ela Glowicka (Wissenschaftszentrum Berlin, Reichpietschufer 50, 10785 Berlin,
Germany. [email protected])

Additional information is available for the following registered author(s):

• Ela Glowicka

Abstract

Governments in the EU frequently bail out firms in distress by granting state aid. I use
data from 86 cases during the years 1995-2003 to examine two issues: the effectiveness
of bailouts in preventing bankruptcy and the determinants of bailout policy. The results
are threefold. First, the estimated discrete-time hazard rate increases during the first four
years after the subsidy and drops after that, suggesting that some bailouts only delayed
exit instead of preventing it. The number of failing bailouts could be reduced if European
control was tougher. Second, governments’ bailout decisions favored state-owned firms,
even though state-owned firms did not outperform private ones in the survival chances.
Third, subsidy choice is an endogenous variable in the analysis of the hazard rate.
Treating it as exogenous underestimates its impact on the bankruptcy probability. Several
policy implications of the results are discussed in the paper.
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Paper provided by SFB/TR 15 Governance and the Efficiency of Economic Systems,
Free University of Berlin, Humboldt University of Berlin, University of Bonn, University
of Mannheim, University of Munich in its series Discussion Papers with number 176.

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Keywords: State aid European Union Discrete-time hazard Bivariate probit

Other versions of this item:

• Paper
o Ela Glowicka, 2006. "Effectiveness of Bailouts in the EU," CIG Working Papers SP II
2006-05, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and
Innovation (CIG). [Downloadable!]

Find related papers by JEL classification:

K2 - Law and Economics - - Regulation and Business Law
G3 - Financial Economics - - Corporate Finance and Governance
L5 - Industrial Organization - - Regulation and Industrial Policy

This paper has been announced in the following NEP Reports:

• NEP-ALL-2006-11-18 (All new papers)

• NEP-EEC-2006-11-18 (European Economics)
• NEP-LAW-2006-11-18 (Law & Economics)

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the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate
adjustments.:
1. Oscar Couwenberg, 2001. "Survival Rates in Bankruptcy Systems: Overlooking the
Evidence," European Journal of Law and Economics, Springer, vol. 12(3), pages 253-273,
November. [Downloadable!] (restricted)
2. Bandopadhyaya, Arindam, 1994. "An Estimation of the Hazard Rate of Firms under Chapter
11 Protection," The Review of Economics and Statistics, MIT Press, vol. 76(2), pages 346-50,
May. [Downloadable!] (restricted)
3. Couwenberg, Oscar, 2001. "Survival rates in bankruptcy systems : overlooking the evidence,"
Research Report 01E15, University of Groningen, Research Institute SOM (Systems,
Organisations and Management). [Downloadable!]
4. Chiara Monfardini & Rosalba Radice, 2008. "Testing Exogeneity in the Bivariate Probit Model:
A Monte Carlo Study," Oxford Bulletin of Economics and Statistics, Department of Economics,
University of Oxford, vol. 70(2), pages 271-282, 04. [Downloadable!] (restricted)
5. Jonathan Beck, 2004. "Fixed, Focal, Fair? Book Prices Under Optional Resale Price
Maintenance," CIG Working Papers SP II 2004-15, Wissenschaftszentrum Berlin (WZB),
Research Unit: Competition and Innovation (CIG). [Downloadable!]
6. Eric Maskin & Chenggang Xu, 2001. "Soft budget constraint theories: From centralization to
the market," The Economics of Transition, The European Bank for Reconstruction and
Development, vol. 9(1), pages 1-27, March. [Downloadable!] (restricted)
Other versions:
o Maskin, Eric & Xu, Cheng-Gang, 2001. "Soft Budget Constraint Theories: From
Centralization to the Market," CEPR Discussion Papers 2715, C.E.P.R. Discussion
Papers. [Downloadable!] (restricted)
7. James J. Heckman, 2001. "Micro Data, Heterogeneity, and the Evaluation of Public Policy:
Nobel Lecture," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages
673-748, August. [Downloadable!] (restricted)
8. Lin, Justin Yifu & Cai, Fang & Li, Zhou, 1998. "Competition, Policy Burdens, and State-
Owned Enterprise Reform," American Economic Review, American Economic Association, vol.
88(2), pages 422-27, May. [Downloadable!] (restricted)
9. Roller, Lars-Hendrik & Zhang, Zhentang, 2005. "Bundling of social and private goods and the
soft budget constraint problem," Journal of Comparative Economics, Elsevier, vol. 33(1), pages
47-58, March. [Downloadable!] (restricted)
10. Li, Kai, 1999. "Bayesian analysis of duration models: an application to Chapter 11
bankruptcy," Economics Letters, Elsevier, vol. 63(3), pages 305-312, June. [Downloadable!]
(restricted)
11. Ela Glowicka, 2005. "Bailouts in a common market: a strategic approach," Discussion Papers
177, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin,
Humboldt University of Berlin, University of Bonn, University of Mannheim, University of
Munich. [Downloadable!]
Other versions:
o Ela Glowicka, 2005. "Bailouts in a Common Market: A Strategic Approach," CIG
Working Papers SP II 2005-20, Wissenschaftszentrum Berlin (WZB), Research Unit:
Competition and Innovation (CIG). [Downloadable!]
12. Ilya R. Segal, 1998. "Monopoly and Soft Budget Constraint," RAND Journal of Economics,
The RAND Corporation, vol. 29(3), pages 596-609, Autumn. [Downloadable!] (restricted)
13. Shumway, Tyler, 2001. "Forecasting Bankruptcy More Accurately: A Simple Hazard Model,"
Journal of Business, University of Chicago Press, vol. 74(1), pages 101-24, January.
[Downloadable!] (restricted)
14. Joseph P. Hughes & Loretta J. Mester, . "A Quality and Risk-Adjusted Cost Function for
Banks: Evidence on the "Too-Big-To-Fail" Doctrine," Rodney L. White Center for Financial
Research Working Papers 25-92, Wharton School Rodney L. White Center for Financial Research.

Other versions:
 o Joseph P. Hughes & Loretta J. Mester, 1991. "A quality and risk-adjusted cost function
for banks: evidence on the " too-big-to-fail" doctrine," Working Papers 91-21, Federal
Reserve Bank of Philadelphia.
15. BOADWAY, Robin & MARCEAU, Nicolas & MARCHAND, Maurice, 1994. "Time-Consistent
Subsidies to Unlucky Firms," Cahiers de recherche 9413, Université Laval - Département
d'économique.
Other versions:
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subsidies to unlucky firms," European Journal of Political Economy, Elsevier, vol.
11(4), pages 619-634, April. [Downloadable!] (restricted)

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U.S. bailouts common; effectiveness is

debatable
by Dave Carpenter / Associated Press

Tuesday September 23, 2008, 3:05 PM

APA woman walks past the office of U.S. insurance

giant AIG, American International Group, in Croydon, South London, Tuesday, Sept. 16,
2008.
CHICAGO -- The stock market plummets, investors pull out money and loans dry up,
triggering global financial turmoil. Enter the government, buying up bad mortgages and
other problem assets.

This scenario from the 1930s sounds eerily current, in part because the Bush
administration is taking pages from the playbooks Herbert Hoover and Franklin D.
Roosevelt used to unfreeze credit and keep Americans from losing their homes three-
quarters of a century ago.

From the Great Depression to the Chrysler bailout in 1979 to the savings and loan crisis
that cost taxpayers $125 billion in the 1990s, the current administration has many
government interventions from which to learn. If the history of previous bailouts holds
any single lesson, however, it's that the outcomes are unpredictable and the problems will
take years to work out.

"Some of these measures have been effective in propping up the economy at times when
our private sector needed a little help," said Scott Anderson, senior economist at Wells
Fargo Economics. "And that's the role of the government. But in the long term there are
negatives."

Some rescues have worked but have turned out to be instances of "pouring money down a
rathole," according to economist Sam Peltzman, citing the 1971 bailout of defense
contractor Lockheed Aircraft in particular. That intervention kept Lockheed afloat
through $250 million in government loan guarantees, although critics say the government
set a poor precedent of rewarding corporations that ran their businesses inefficiently.

"The individual cases can work out well," said Peltzman, professor emeritus of
economics at the University of Chicago Graduate School of Business. "But in the long
run you're just laying the groundwork for more because you're giving people an incentive
to take too much risk, where a big part of the risk gets laid off on the taxpayer."

While the government stepped in to resolve banking panics several times in the nation's
first 150 years, 20th-century precedents are heeded more closely -- none more so than the
country's worst financial meltdown.

A student of the Depression, Federal Reserve Chairman Ben Bernanke well knows that
the government's slowness to step in following the Crash of 1929 is often blamed for
contributing to what turned out to be a full decade of economic misery. By the time the
government took comprehensive action, unemployment was 25 percent, much of the steel
business had disappeared, and thousands of homeowners a week were losing their houses
to banks.

The Hoover administration created the Reconstruction Finance Corp. in 1932 to spur
economic activity by first lending money to financial, industrial and agricultural
institutions, then injecting capital into thousands of banks by investing in their preferred
stock.
The RFC fared well financially and did not ultimately prove a costly burden for
taxpayers, according to Richard Sylla, financial historian and economist at New York
University's Stern School of Business. By the time it closed up shop in 1957, it had made
loans of about $50 billion.

The same held true for the Home Owners' Loan Corp., started under FDR in 1933 as part
of the New Deal. The agency helped stop a flood of foreclosures by buying $3 billion
worth of defaulted mortgages and refinancing more than a million loans at lower rates
and longer terms.

The government also created the Federal Deposit Insurance Corp. the same year,
guaranteeing the safety of checking and savings deposits in member banks following a
wave of bank failures.

As with many interventions, the notion of the government putting taxpayers on the hook
for a huge financial burden was not popular at first.

"The 1930s reforms were detested at the time," Sylla said, describing the initial public
reaction. "But later on people said they really were pretty good."

The '70s and '80s brought a series of government rescues of corporations -- including
Lockheed and Continental Illinois National Bank and Trust -- but none was more
heralded than the 1979 bailout of Chrysler Corp. The nation's 10th-biggest company had
fallen into near-collapse amid high oil prices that tanked demand for its big cars, and the
Carter administration arranged for $1.2 billion in subsidized loans. That spurred a
Chrysler comeback and ultimately netted a profit for the government when Chrysler
made good on its obligations.

The Chrysler bailout is widely regarded as a success. But Barry Ritholtz, who writes the
popular financial blog The Big Picture and is CEO of research firm FusionIQ, argues in a
soon-to-be-published book, "Bailout Nation," that it actually helped cause the decline of
the auto industry. Automakers kept on doing business as usual after the rescue, he
maintains, rather than learning a needed lesson about Chrysler's decline and overhauling
their attitude toward fuel efficiency and manufacturing quality.

"It's a slippery slope," Ritholtz said of government intervention. "In theory, you shouldn't
be doing any bailouts unless it's truly systemic risk."

The S&L crisis was the costliest intervention ever -- soon to be dwarfed by the current
plan to buy up to $700 billion in mortgage-related assets. It was caused by the industry's
expansion into commercial real-estate lending in the wake of deregulation and amid poor
oversight, not unlike the explosion of subprime mortgage lending two decades later.

With increasing numbers of savings and loan associations insolvent, doomed by higher
interest rates, Congress in 1989 established the Resolution Trust Corp., a government-
owned asset management company charged with taking over troubled assets and paying
depositors their lost funds. By the time it wrapped up business in the mid-'90s, more than
700 S&Ls had failed.

"I think the lesson learned from that was that we don't want to create an institution that's
going to be around for 50 years," Anderson said. "We wound down the RTC fairly
quickly, and hopefully we'll be able to do that this time."

Effectiveness of $700 Billion Bank Bailout Cannot Be Measured

Tuesday, February 10, 2009
By Edwin Mora

In this Sept. 24, 2008 file photo, Federal Reserve Chairman Ben Bernanke (right),
accompanied by Treasury Secretary Henry Paulson, testifies on Capitol Hill. (AP
Photo/Manuel Balce Ceneta)
(CNSNews.com) - So far, the government has not been able to measure the effectiveness
of the $700 billion bank bailout passed by Congress last fall, according to the
Government Accountability Office (GAO), the investigative arm of Congress.

In fact, the GAO said it’s not yet possible to know exactly where the money is going, let
alone the effectiveness of the Troubled Asset Relief Program (TARP), which was created
last October when Congress authorized $700 billion to help financial markets.

“We are not actually sure how it (TARP) is functioning,” Tom McCool, director of the
center of economics at GAO, told CNSNews.com. “Part of it is because of data
limitations.”

The Emergency Economic Stabilization Act of 2008 requires the Comptroller General,
who heads GAO, to report at least every 60 days on TARP's performance--including how
well the program is performing, the disposition of assets and an accounting of TARP’s
internal operations.

On Jan. 30, GAO released its second report on how the Treasury Department has been
managing TARP, telling Congress that Treasury is still in the process of hiring staff for its
Office of Financial Stability--and “still developing an oversight structure” for the
program.”
On Feb. 5, Gene Dodaro, head of the GAO and acting comptroller general, testified
before the Senate Committee on Banking, Housing, and Urban Affairs.

He acknowledged that in the time since the GAO released its first report on the bank
bailout in December, the Treasury has “not fully exercised” GAO’s recommendations
about providing information of how recipients are handling funds, but has taken a few
steps in that direction.

One "step" government auditors want is a monthly survey of how each of the 20 largest
recipients of TARP funds are using the money. Another is quarterly surveys of the rest of
the institutions.

But Dodaro pointed out that this would only be the beginning of accountability for the
program.

“While the monthly survey is a step toward greater transparency and accountability for
the largest institutions,” Dodaro told the committee, “we continue to believe that
additional action is needed to better ensure all participating institutions are accountable
for their use of program funds.”

According to Dodaro, all institutions should report their use of funds on a monthly basis.

The GAO is planning to use the data of how recipients are using funds to measure
whether the program is actually helping the economy--or making it more vulnerable to
the current financial storm, McCool said.

“It [data] should give us a sense if it is working or not,” he said, “at least for those
institutions.”

McCool added that the GAO is expecting the first data from the 20 institutions sometime
this week.

In addition to accountability deficiencies, TARP suffers from “a lack of transparency,”

and it has “no central vision,” according to Dodaro.

The GAO also noted that regulators will face difficulty in monitoring the program.

“It is unclear how OFS [Office of Financial Stability] and the regulators will monitor
participating institutions’ use of the capital investments,” stated the first GAO report
released in December.

It added that out of eight institutions that initially received funds from the program only
two treated the funds separately from their other capital.

“With the exception of two institutions, institution officials noted that money is fungible
and that they did not intend to track or report CPP capital separately,” the report said.

inancials push TSX lower on doubts

about effectiveness of US bailout;oil
surges
Mon Sep 22, 4:59 PM
Malcolm Morrison, The Canadian Press

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(The Canadian Press)

By Malcolm Morrison, The Canadian Press

TORONTO - A selloff in bank and insurance stocks helped push the Toronto stock
market down sharply Monday while energy stocks failed to respond to a huge jump in
crude prices.

New York markets were also firmly in the red as investors awaited more details of the
Bush administration's plan to revive frozen credit markets. "It's really hard to know if
we're in the eye of the storm or in its wake," said Brendan Caldwell, president of
Caldwell Securities.

"My feeling is that there will be another real opportunity in this market to make some
money but I'd like to get the trend established beforehand. It's been so volatile."

Toronto's S&P/TSX composite index fell 274.92 points to 12,638.07 keeping most of a
848-point surge on Friday. New York's Dow Jones industrial average lost 372.75 points to
11,015.69 after charging ahead 369 points Friday.

The Toronto market was also buffeted by declines in industrial, tech and telecom stocks.
The energy sector lost 1.75 per cent even as the October crude contract on the New York
Mercantile Exchange surged $16.37 to US$120.92 a barrel, after going as high as
US$130 on its final day of trading. The November crude oil contract was up only $6.62
to US$109.37.

The jump in oil came amid a weakening U.S. dollar as investors mulled over the final
cost of the plan announced Friday by Treasury Secretary Henry Paulson to buy US$700
billion of toxic mortgage debt.

But, it is not clear how successful the Paulson plan will be in loosening debt markets and
propping up the sinking housing market.

"The Americans are issuing massive amounts of U.S. dollars on the market and most
Americans that have figured this out will go to hard assets, the best hard assets in
commodity plays are oil and gold," said Andrew Martyn at Davis Rea Ltd.

The TSX Venture Exchange moved up 26.77 points to 1,575.99 and the Canadian dollar
was up 1.53 cent at 96.77 cents US as the American dollar moved lower against most
major currencies amid worries about the inflationary impact of the financial-sector
rescue.

The Nasdaq composite index was down 94.92 points at 2,178.98 while the S&P 500
index declined 47.99 to 1,207.09.

The financial sector was the biggest weight on New York indexes as Citigroup lost 64
cents to US$20.01 and Washington Mutual fell 92 cents to $3.33.

In Toronto, the financial sector fell three per cent after big gains Friday. Royal Bank
(TSX: RY.TO) gave back $1.43 to $50 and Scotiabank (TSX: BNS.TO) declined $2.19 to
$47.81.

Manulife Financial (TSX: MFC.TO) moved down 87 cents to $36 following a report it is
set to bid for parts of AIG.

Fairfax Financial Holdings Ltd. (TSX: FFH.TO) jumped $25 to $320 after it disclosed
Monday that it has US$2.1 billion in realized and unrealized gains on credit default
swaps.

The gold sector ran ahead 6.7 per cent as the December bullion contract in New York
gained $44.30 to US$909 an ounce. Barrick Gold jumped $3.11 to $39.61 and Goldcorp
Inc. (TSX: G.TO) advanced $3.39 to $37.89.

Energy sector losers included Canadian Natural Resources (TSX: CNQ.TO), down $2.84
to US$84.47 while EnCana Corp. (TSX: ECA.TO) gave back $1.55 to $74.20.
Tanganyika Oil (TSX: TYK.TO) surged $6.30 or 36 per cent to $23.80 after it said it has
entered into talks to sell the company.

Research In Motion Ltd. (TSX: RIM.TO) was a drag on the TSX, losing $8.11 to
$101.39.

The telecom sector was also down as Telus Corp. (TSX: T.TO) shed $1.58 to $38.47.

The Toronto income trust sector closed lower, down 1.1 per cent, after the Liberals said
they would roll back a looming tax on such trusts introduced by the Tories nearly two
years ago.

Elsewhere, Angiotech Pharmaceuticals Inc. (TSX: ANP.TO) shares were down 38 cents
28 or per cent to 98 cents after it announced it is moving to cut costs and "further focus
its business efforts," while disclosing that a previously announced capital injection of up
to $300 million is in doubt.

On the TSX, declines beat advances 879 to 742 with 166 unchanged as 457 million
shares traded worth $8.02 billion.