Economic Bailout Causes

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. Download Info To download: If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help file. Note that these files are not on the IDEAS site. Please be patient as the files may be large. File URL: http://www.sfbtr15.de/dipa/176.pdf File Format: application/pdf File Function: Download Restriction: no Publisher Info

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. Download reference. The following formats are available: HTML, plain text, BibTeX, RIS (EndNote), ReDIF Length: Date of creation: Oct 2006 Date of revision: Handle: RePEc:trf:wpaper:176 Contact details of provider: Postal: D-68131 Mannheim Fax: +49 621 181-2785 Email: [email protected] Web page: http://www.sfbtr15.de/ More information through EDIRC For technical questions regarding this item, or to correct its listing, contact: Jung).

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Related research 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: • • •

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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 StateOwned 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:

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. BOADWAY, Robin & MARCEAU, Nicolas & MARCHAND, Maurice, 1994. "Time-Consistent Subsidies to Unlucky Firms," Cahiers de recherche 9413, Université Laval - Département d'économique. Other versions: o Boadway, Robin & Marceau, Nicolas & Marchand, Maurice, 1996. "Time-consistent subsidies to unlucky firms," European Journal of Political Economy, Elsevier, vol. 11(4), pages 619-634, April. [Downloadable!] (restricted) o

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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 threequarters 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 governmentowned 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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Enlarge Photo (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.