Media Clips
International Herald Tribune (France)
September 10, 2008
Bailout Has U.S. Walking Risky Tightrope
By Nelson D. Schwartz and James Kanter
Is the definition of what's too big to fail getting broader?
Over the past decade, Washington has thrown a lifeline to everything from Long-Term Capital Management, a troubled hedge fund, to the airline and insurance industries after the Sept. 11 terrorist attacks in 2001. Now, Fannie Mae and Freddie Mac, the mortgage finance companies whose rescue plan was announced Sunday, are the latest to join the club.
In all these cases, the overall risk to the U.S. economy of an outright collapse was judged by policy makers to be greater than what economists term the moral hazard problem - the fear that the private sector will take on greater, even foolhardy, risks in the future as investors in major businesses, and their executives, assume that government, with its essentially bottomless pockets of cash, will always be there to provide a backstop.
None of this is entirely new, of course, either in the United States or elsewhere around the world.
Still, in the wake of the help for the mortgage giants and the rescue of the investment house Bear Stearns in March by the U.S. Treasury Department and Federal Reserve, there is already talk among economists, Wall Streeters and politicians about which companies or industries will be the next to belly up to the bar. And experts are looking at the possibility that Lehman Brothers, the troubled Wall Street investment firm, or Detroit automakers will seek assistance from Washington to deal with their problems.
To be sure, many analysts agree that Fannie and Freddie do not necessarily set a precedent, because of their longstanding relationship with the government and the vast holdings of their debt by banks in Asia and Europe. But even supporters of their rescue make clear that it may be time formally to acknowledge Washington's ever-expanding role as the backer of last resort.
''Fannie and Freddie are a special case, but there is a bigger question,'' said Jonathan Koppell, director of the Millstein Center for Corporate Governance and Performance at Yale. ''Do we live in a market economy or not? If we do, it seems companies have to be allowed to fail. If we say companies can't fail because they're too big or the consequences are too great, we have something else.''
If the government does increasingly have to step in, Koppell said, perhaps Washington should charge companies along the lines of how banks are charged fees to provide insurance for depositors.
Or if more companies are literally judged to be too huge to go down, then antitrust regulators should reconsider allowing more mega-mergers in the future.
''It might sound radical to regulate companies on the basis of their size, but we've adopted a de facto 'too big to fail' policy, and that's also pretty radical,'' he said.
In Europe, where the tradition of government intervention is considerably stronger than in the United States, the European Union has been grappling with similar issues for many years.
The EU has extensive laws governing bailouts to curb interventionist zeal among member states, and regulators at the European Commission in Brussels frequently warn member states that government handouts distort competition and reward inefficiency.
But in practice, governments have often proceeded with bailouts to protect industrial and financial giants, even as regulators struggle to assess whether governments violated the rules.
''Europe has a long history of trying to ensure that companies like airlines and lenders that are too big to fail, don't fail,'' said Sebastian Vos, a director at the Brussels office of Fipra International, a firm offering public policy and regulatory advice. ''The European Commission does try its hardest to police these bailouts and make sure that they don't skew the competitive landscape, but it's often an uphill battle.''
In Washington, the ink on the plan to save Fannie Mae and Freddie Mac may not be dry, but already there are signs that other industries may soon seek government help. In recent months, doubts about the financial health of U.S. automakers have been rising, and both presidential candidates, the Republican John McCain and the Democrat Barack Obama, have voiced support for providing billions in loan guarantees to Detroit.
What about the moral hazard problem? The solution to that seems to be to wipe out the shareholders in companies that are rescued and force out the executives who brought about the disaster, said Byron Wien, a longtime veteran of Wall Street who is the chief investment strategist at Pequot Capital.
''The government is saying that they'll help but the guy who comes to Washington to ask might be the first to go,'' Wien said. ''And they're telling shareholders, 'If we provide help, you might be wiped out.'''
As for Europe, the highest profile corporate rescue this year concerned Northern Rock, a British mortgage lender whose business collapsed because of the global credit crisis that began in the United States.
The British government nationalized Northern Rock in February, but only after giving the bank tens of billions of pounds in loans and guarantees, prompting an investigation. The European Commission is still examining the case after warning earlier this year that British aid to Northern Rock may be more generous than necessary.
EU investigators are also looking at the state bailouts of WestLB, a bank in Germany that got into trouble from investments tied to the U.S. subprime mortgage crisis.
Another inquiry focuses on the moribund Italian national airline, Alitalia. EU regulators have forbidden further state aid to Alitalia, which received a loan of €300 million, or $423 million, approved by the caretaker government of Romano Prodi in April with the approval of his successor, Silvio Berlusconi.
French governments have had a particularly long record of finessing Europe's state aid rules. In 2004, the European Union concluded that France had violated the bloc's rules on state aid by offering France Télécom a €9 billion line of credit. But the French government argued successfully that it had done nothing wrong because the company never actually used the credit line.
French governments also bailed out Air France and Crédit Lyonnais, a bank controlled by the state at the time. The rules permitting such bailouts have since been changed.
Under EU rules, the regulators can order governments to reclaim the aid at a later date. In the end, though, most European governments get what they want, even if they have to go so far as to claim, as Washington has done, that a bailout was necessary to avoid a financial crisis.