'Bailout' Capitalism: Two Years On

Dean Baker
International Relations and Security Network, November 25, 2010

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In the fall of 2008 major financial institutions were failing across the globe. They had over-leveraged themselves in supporting the housing bubbles that had grown up in the US and much of the rest of the world. Banks had enmeshed themselves not only in the loans that directly supported these bubbles, but also in complex and poorly understood derivative instruments. When the bubble began to deflate, a toxic mix emerged that threatened to bring down the international financial system.

In this context, governments across the globe rushed in to save their largest financial institutions from collapse. They also intervened to protect some large non-financial institutions, most notably General Motors and Chrysler, whose survival was threatened by the fallout from the collapse.

These bailouts led many to become concerned about the increasing role government played in the economy. Some conservatives in the US even raised the uniquely American alarm over 'socialism'.

Now that the world has pulled back from the financial crisis and some time has passed, it should be very clear that this spate of intervention had nothing to with socialism – or even an expansion of the government’s role in the economy. These bailouts were about rescuing the bankers in their moment of need, saving them from their own greed and recklessness.

While the financial reform bill in the US and regulatory changes elsewhere are likely to prevent some of the worst abuses that led to this crisis, it looks very much like the end result of government intervention was the restoration of the status quo ante. In fact, the US financial sector is more heavily concentrated than ever as a result of several major mergers that took place in the midst of the crisis, without being subject to the scrutiny that such consolidations would ordinarily face.

'Pure' market economy? Pure fiction.

The notion of a 'pure' market economy – in which the government sits back and just lets the chips fall where they may – has always been a fiction. The government sets the ground rules in ways that impact significantly on economic outcomes.

For example in the US, the rules of corporate governance allow top executives to largely run the companies in their own interest, marginalizing shareholders. As a result, the pay for those in charge can often run into the tens or even hundreds of millions of dollars, figures that dwarf the compensation packages of even the most successful bosses in Europe and Japan.

Rules on copyright and patents make it possible for the Bill Gates and Lady Gagas of the world to get enormously wealthy. It is easy to imagine less strict protections or altogether different mechanism for financing creative work and innovation that would not make it as easy to gain such vast fortunes.

And of course governments set the rules around labor management relations. Rules that are more labor friendly make it easier for workers to organize unions and bargain effectively. As a result, they are likely to get a bigger piece of the pie.

But the bailouts of 2008 went beyond just rule-setting; it was active intervention. Dozens of major banks in the US and across the world would have faced bankruptcy had governments not stepped in to support them.

Ostensibly the reason for this intervention was to maintain an operating financial system. This is debatable. Certainly the intervention could have come with more stringent conditions than it did – for example strict compensation caps and severe restrictions on speculative behavior.

Governments also could have allowed the banks to collapse and stepped in to pick up the pieces after the fact. This may have led to a few scary weeks, but we do know how to get money back into the financial system, having learned a lot about monetary policy since the 1930s.

Most of the interventions came with relatively few conditions. Clearly the goal was to save the banks and to largely restore them to their prior position. This goal was accomplished, with bank profits and bonuses in the US and elsewhere having risen back to their pre-recession levels.

This should be troublesome. These huge banks should be able to look out for themselves in a market economy. They are happy to pocket the profits when times are good; this should mean that they are willing to suffer the losses in bad times as well.

However, this is not what happened in 2008 and is probably not what will happen the next time the major banks face a serious crisis. It is likely that they will again turn to the government and get whatever money is needed to stay afloat. 

This narrative is precisely the opposite of the one that has government encroaching on the role of the private sector. Instead, wealthy private interests are using their power to tap government coffers as a source of limitless and unpaid insurance. This is not the way a market economy or democracy is supposed to work – and it certainly doesn't constitute 'socialism'.  Citizens do, however, have a right to be very upset.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.