New Book Examines the History and Folly of Bank Bailouts

Financing Failure shows us the appalling lack of logic in regulators' responses to financial crises and how, sadly, we can expect more of the same in the next crisis.” —Jean Helwege, Professor of Business Administration, University of South Carolina; and former Senior Economist, Federal Reserve Bank of New York

No issue during the recent financial crisis aroused more passion than the bailouts of large banks and other financial institutions. Polls conducted during the peak of the crisis in September 2008 revealed that the American public overwhelmingly objected to the bailouts. Yet, although numerous books and articles have reported on the crisis, few have looked closely at the government agencies responsible for deciding whether or not a financial institution gets bailed out. Independent Institute Research Fellow Vern McKinley remedies this shortcoming in his penetrating new book, Financing Failure: A Century of Bailouts.

Financing Failure shows that to make sense of the bailouts—to understand why banking regulators have invoked this controversial policy option—we must examine several decades of banking legislation and institutional change. A veteran regulatory expert who has worked for several financial regulatory agencies, McKinley shows how the latest crisis eerily resembles those of the 1930s and 1980s, and how with each passing crisis, government interventions have become broader and more entrenched, with a growing segment of the financial industry receiving bailouts and a growing number of regulatory agencies taking part in the process. Alarmingly, those agencies have often worked at cross-purposes, making mistakes that have undermined public confidence and economic recovery.

Moreover, the regulatory agencies have often impeded independent investigations of the bailout process, as McKinley learned first-hand while researching his book. One reason for their lack of transparency may be that the case for bailouts is surprisingly weak: no clear evidence has been presented that substantiates claims that the failure of a bailed out institution would have jeopardized the entire financial system. Thus, the policy of bailing out banks deemed “Too Big To Fail” seems to be based on bureaucratic imperative, not on a calculated estimation of the threat of “systemic risk.”

“The usual pattern is that [the government bailout agencies] overreact in the midst of a financial crisis because they feel they have to ‘do something,’” McKinley writes in his concluding chapter. “Most of these actions make matters worse in both the short term, as the panic spreads more broadly, and in the long term, as unintended consequences flow from their initial reaction.”

Financing Failure can be read profitably by a general audience, but readers well versed in banking, finance, or government affairs will especially appreciate its thorough account of the rise of massive bailouts and of the bureaucratic decision-making process that has sought to rationalize them.

Purchase Financing Failure: A Century of Bailouts, by Vern McKinley.

Read a detailed book summary.

[This post appeared first in the January 10, 2012, issue of The Lighthouse. To subscribe to this weekly newsletter of the Independent Institute, enter your email address here.]

Carl Close is Research Fellow and Senior Editor for The Independent Institute and Assistant Editor of The Independent Review and editor of The Lighthouse, The Independent Institute’s weekly e-mail newsletter.
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