The Real Cost of the 2008 Bailouts

When businesses come asking for money, government officials will find it hard to say no.

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Hester Peirce is a senior research fellow at the Mercatus Center at George Mason University.

Today marks the four-year anniversary of the Bear Stearns collapse that opened the door to a series of taxpayer bailouts of AIG, Fannie, Freddie, many banks, and the auto companies. These bailouts imposed tremendous direct and indirect costs on our society and set a poor precedent on how to deal with future crises.

Even Treasury Secretary Tim Geithner acknowledged in the Wall Street Journal earlier this month that the Dodd-Frank Act "will not prevent all future financial crises." Despite the harm caused by bailouts, during the next crisis, we can expect more of the same. Faced with the aggressive intervention of regulators in 2008, when the next crisis occurs, future regulators will feel pressure to repeat the Geithner era bailouts, rather than make the tough choices.

[See a collection of political cartoons on the economy.]

The direct costs from the bailouts come from regulators pouring taxpayer money directly into banks and other companies. Claims that this was a terrific investment are both premature and misleading. They are premature because the government still holds large stakes in companies like AIG and General Motors, and because more than 300 banks still hold TARP funds. They are misleading because they ignore the fact that taxpayer money was invested when, according to regulators, nobody else was willing to invest. Taxpayers should not be content with simply getting back the money they put in four years ago. They should expect a high rate of return to compensate them for the risk they took.

In addition to these direct costs, bailouts disrupt the way markets function. When the government sends the message that it will stand in for big players in the market that cannot meet their obligations, companies stop worrying so much about their business partners. They might even favor doing business with big companies, since those are the ones that are likely to get bailed out.

During a financial crisis, regulators have a legitimate interest in calming irrational fears and preventing runs on fundamentally healthy banks, but during 2008, regulators took active steps to confuse the markets. Regulators handed out money to sick entities, such as Citigroup, to make them appear healthy and dumped money into troubled markets, such as housing, to prevent true market prices from being revealed. Hiding the truth only prolonged and deepened the financial crisis.

[Read the U.S. News debate: Should the Dodd-Frank Act Be Repealed?]

By rescuing some firms and letting others like Lehman fail, the bailouts allowed regulators to pick winners and losers. J.P. Morgan secured government support to sweeten its purchase of Bear. Regulators rescued hand-picked companies with vocal advocates, such as General Motors, or important counterparties, such as AIG. Not only were these companies bailed out, some TARP recipients continued to get favored treatment long after the initial rescue. For example, AIG and GM enjoy special tax privileges not available to their competitors.

Regulators, faced with another crisis in the future, will look to this precedent of preferential treatment for some and not others set by Secretary Geithner and his colleagues in 2008. When businesses come asking for money, government officials will find it hard to say no.

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