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A Class on Bailouts

posted by Bob Lawless

In early 2008, I had to figure out what courses I would teach in the next academic year, and it was decided that I would offer a seminar of some sort in the 2009 spring semester. "Just call it a seminar on consumer credit as a placeholder in the course listing," I said. It seemed likely that such a seminar would be timely. Who knew? By the fall, of course, we were in a full-blown financial crisis, and the seminar became the Bailouts class.

Students looking for me to lecture from the front of the room with answers will be disappointed. I have more questions than answers. Although the seminar became more of a class as enrollment grew, I still intend to conduct the class principally as I would in a seminar with emphasis on reading and discussion.

Consider one issue that kept coming up as I went to put this class together. It became increasingly difficult to get a handle on exactly what a bailout is. During the current crisis, pundits scream for or against various proposals and invoke the "b" word often. Usually, the term "bailout" is used in derogatory fashion as its user tries to invoke an image of an undeserved government handout. I began to wonder whether the term had any real meaning or was just a word used to characterize a situation for political gain. How do we distinguish a "bailout," for example, from an ordinary government "subsidy?" Is the fact that bailouts usually occur amidst some crisis? Is a bailout just a subsidy decided under hurried political conditions?

My goal is for the course to explore four questions:

(1) What is a "bailout"
(2) Why do governments engage in bailouts?
(3) What makes for a successful bailout?
(4) How can we identify situations in advance where a bailout should occur?

Maybe the third and fourth questions are the same, although my notion is to separate the theoretically pure inquiry from the practical political reality implied by the fourth question. It should be a fun semester.

Comments

Anna Gelpern takes on some of these questions expertly with an array of international examples in her forthcoming paper: http://ssrn.com/abstract=1324306
(so far only the abstract is up but I expect we'll see the full paper any day now!)

I think question 2 points out the real difference between questions 3 and 4: the definition of "successful bailout" may not be congruent with "bailout should occur." I suspect that most observers would view a bailout as successful in solely financial terms. However, there are probably quite a few circumstances in which nonfinancial context must be considered, such as a hypothetical instance concerning the only provider of software essential for running the national power grid, or the only manufacturer of spare parts for nuclear reactors on naval vessels, or some other industrial/quasiindustrial concern related to infrastructure matters that are not easily quantified for financial analysis. For that matter, there is an interesting essay at Balkinzation (first part only posted so far) on newspaper publishing that points at a potential distinction (see
http://balkin.blogspot.com/2009/01/future-of-news-part-one-problem.html
).

Thanks for the tip, Alan. You're not the first one to suggest Anna's new article as a resource for the class. It sounds like it will be quite useful.

What is a bailout/why/when is it a success?

I recently read "Bailout" by FDIC Chair Irvine Sprague, a book about the bailout of four banks in the 70's and 80's, most notably Continental Illinois. Back then, the FDIC defined "bailout" as when it took over a bank, such that the FDIC paid creditors and depositors in full under the "essentiality" doctrine. Don't know if the doctrine exists today. Sprague introduces the concept of "too big to fail". That time period is different than the financial crisis of today, yet bank execs made similar mistakes. Today, the errors in prudence are more widespread.
Another parallel is that during that period, the FDIC Board (3 members) had the power to decide whether to spend the money to do a bailout of a bank. Sprague notes in contrast and in passing that federal help to Chrysler, NYC and Lockheed was hotly debated in Congress.

You might want to consider excerpts of the book for class readings.

A detailed description of the book is at: http://www.beardbooks.com/beardbooks/bailout.html
(no affiliation)

Barry Ritholtz of The Big Picture blog has a new book coming out entitled, "Bailout Nation".

I wonder how these wide policy of bailouts stretching from banks to car manufacturers will change the basis of the State Aid, at least in the EU where, as you know, the Comission has been very severe. It seems a less strict time is about to arrive, even if the rules are still the same. Might this be one of the key questions regarding bailouts (state money aids, we should not forget)?

bailouts, from what I can tell, happen because it's easier to redistribute money by injecting it into the economy than taking it away via taxes.

I think "bailout" is following a form of Keynesian thought. ie. deficit spending (to prime the pump so to speak). What is weird to me is that just like slaughtering a bunch of pigs or plowing under a portion of your corn crop was a proposal to raise profits by increasing the price of the commodity. It seems as though the "New form of lowering wages" is for our major corporations following each other in massive layoffs (although my Mom says there is nothing new under the sun re: Profit Isaiah or was is Ezekiel?). They then can re-hire later, paying less wages, saving on health care, insurance etc. (all the while getting bailout money). Their "goal" to me anyway is to lower wages across the board. You can't lower wages across the board without some form of coordination with competitors in your same market. A form of Wage fixing. Why don't they just cut wages by 3-10% across the board instead of laying off a ton of people? Especially if they get TARP (bailout)money, which we already know was used to PAY BONUSES!

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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