You are on page 1of 6

Griffin 1

Trey Griffin

Kelsey Helveston

UWRT 1102

20 April 2017

Inquiry Project

For my inquiry topic, I wanted to research whether big bank bailouts from the

government hurt or help the economy and banks in the long run. I wanted to look at this from a

pure business and economic perspective. Rather than the ethical or political conversation on if

the government is overstepping its boundaries by bailing out the banks. This topic interested me

because this is a situation that happened about nine or eight years ago and very much applies to

the well-being of the economy. During the recession that started around 2008, the government

ultimately decided to bailout the big banks.

On October 3, 2008, the United States government passed the Emergency Economic

Stabilization Act of 2008. This act was a $700 billion financial sector rescue plan, the largest

bailout in American history by hundreds of billions of dollars (Davis). The main idea behind the

bill was authorize the US Treasury to buy risky and nonperforming debt like mortgages, car

loans, and college loans from various lending institutions. The whole goal was to have the trust

in banks reestablished because the US economy runs on lending between banks and consumers.

Some would argue that this bailout worked because the economy has since improved, but others

would say the economy improved only because it’s just the natural cycle the economy runs.

One perspective I’m going to look at is not bailing out the banks. Chunyang Wang, an

Economics professor with a PhD, used the recent financial crisis of 2007-2009 for his research.

His paper develops a global game model of information based on bank runs to analyze how the
Griffin 2

announcement of bailouts affects the investors’ bank run incentives. A bank run is when a large

number of people try to withdraw their money from a bank all at the same time and if enough

people try to take out money the bank may not have enough in reserves to meet the demands. He

says bank runs became more prevalent during the 2007-2009 financial crisis. “In the years of

2008 and 2009, 165 banks failed in the US, in which bank runs are a notable cause. However,

only 11 banks failed in the five years before 2008” (Wang). In Wang’s model the probability of

bank runs after a bailout announcement depends on three factors. The first is that the probability

of a bank run is higher if the bailout amount is smaller. The second is that the probably of a bank

run is higher if the government signal is more precise. Third, the probability of a bank run is

higher when the government uses a lower cutoff. This is because investors see a lower cutoff it

they believe that the government believes the bank is worse. He concludes that, after the

announcement of a bailout investors may run on the bank, since such an announcement reflects

that the government has information about the bad bank assets (Wang).

Another point of view I’m going to look at is a study of bank bailouts in Europe and bank

performance after the bailouts. Maria Gerhardt and Rudi Vander Vennet, who are Finance and

Economics professors at universities in Europe, looked at the 114 European banks that benefited

from government support during the financial crisis in Europe. They investigated the financial

condition of banks before and after receiving government support. In their journal, it says that

the equity ratio, loan quality and bank size are the main determinants of bank bailout

involvement. They found that the aided banks hardly improved their performance indicators in

the years after government aid, indicating that bailouts are not enough to restore bank health

(Gerhardt). In theory, government support should allow banks to restructure and improve their

risk/return profile. However, it has shown that rescued banks do not reduce riskiness more than
Griffin 3

non-rescued banks. Their recommendation is that when governments set up state sponsored

rescues, they should require rapid and decisive action from the rescued banks in terms of

business model redesign and structural governance changes.

The argument to bailout banks is one that has gained more traction and expanded these

past few years because of the 2008 bailout. When the US government was deciding if they

should bailout the banks they realized a few things. Banks were afraid to lend to each other

which caused stock prices to plummet. Financial firms were unable to sell their debt and

therefore had no way of raising capital and were in danger of going bankrupt without

government intervention. The biggest argument against bailouts by the taxpayers is that they are

the ones paying for bad business practices. However, in the case of the $700 billion that was

approved to spend by congress in the TARP bailout, only $350 billion of that was spent by

George Bush. The money went to big financial institutions and large auto companies. Also, the

government bought the bank stocks while the prices were low and later sold them when they

were higher. As a result, by 2012, only around $100 billion of TARP funds were still unpaid,

banks had repaid $292 billion through stocks, taxes, and payment plans (Amadeo).

Perhaps the industry that was impacted the most by the recession and financial crisis was

the auto industry. The TARP bailout included a bailout package to General Motors, a huge

American auto company, and a few other auto companies. Auto companies received about $80

billion in loans and a recent study found that the loans prevented the immediate loss of 2.6

million jobs in 2009 (Bump). Only $10 billion of the original $80 billion was still outstanding as

of 2013. If the numbers are broken down, the US invested about $12,000 a person to keep their

jobs and those employees contributed about $105 billion in “unemployment benefit payments

and the loss of personal and social insurance tax collections” which equivocates to about a
Griffin 4

$58,000 net profit per person (Bump). This means that even though the US spent money to help

workers keep their jobs, in the long run they money they made back by workers keeping their

jobs, trumped what they spent.

Most of the people that argue for government bailouts, like to mention how it saves jobs

and keeps banks from failing. These are very valid points however, one impact of bailouts that is

rarely thought of is how they impact the non-bailed out banks. Hendrik Hakenes, Isabel

Schnabel, and other economic and finance professors around the world conducted research on

this very topic. They found that bailouts created a competitive advantage among the banks that

weren’t bailed out. The banks that weren’t bailed out had to increase risk taking to try and keep

up with the banks that were benefitting from the bailout. Risk taking benefits the economy

because it means there is more money flow and investing. Investing, loaning, and spending all

help drive the economy because it keeps companies in business and the workers employed.

There will always be people who don’t agree with either side which is why compromise

is sometimes necessary to pass legislation and bills, so that’s why I am going to propose potential

compromises when it comes to bailouts. A potential plan that could be used could be when banks

are bailed out they are required to pay back the government over a set period of time, but also to

be required to change the bad business practices that got them in the bad situation in the first

place. If the government just gives the banks money and doesn’t make them change anything

they might just get themselves back in a similar situation.

The question of government bailouts and if they are beneficial for the economy is a very

important question that matters because wrong decisions when it comes to bailouts can cripple an

economy for years. There is research that supports both sides of the argument and there is also a

political side of things, some don’t think government should be involved with the economy. All
Griffin 5

we know is that there will most likely be another economic downturn due to the cyclical

economy. There are natural downturns and upturns, and when a downturn comes there needs to

be a set plan in place, even if the plan is to do nothing. The best way to do this is to look at

bailouts in the past and see the impacts they had and form an opinion on whether the impacts

were, negative or positive.
Griffin 6

Works Cited

Amadeo, Kimberly. "What Did the Bank Bailout Bill Really Do?" The Balance. N.p., 08 Sept.

2016. Web. 01 Apr. 2017. <https://www.thebalance.com/what-was-the-bank-bailout-bill-

3305675>.

Bump, Philip. "The Auto Bailout Saved 1.5 Million Jobs - and Likely Made $50,000 on Each

One." The Atlantic. Atlantic Media Company, 09 Dec. 2013. Web. 30 Mar. 2017.

<https://www.theatlantic.com/politics/archive/2013/12/auto-bailout-saved-15-million-

jobs-and-likely-made-government-money/355943/>.

Davis, Marc. "Top 6 U.S. Government Financial Bailouts." Investopedia. N.p., 13 Oct. 2008.

Web. 01 Apr. 2017. <http://www.investopedia.com/articles/economics/08/government-

financial-bailout.asp>.

Gerhardt, Maria, and Rudi Vander Vennet. "Bank Bailouts in Europe and Bank Performance."

Finance Research Letters (2016): n. pag. Web. 15 Mar. 2017.

<http://dx.doi.org.librarylink.uncc.edu/10.1016/j.frl.2016.12.028>.

Hakenes, Hendrik, and Isabel Schnabel. "Banks without Parachutes: Competitive Effects of

Government Bail-out Policies." Journal of Financial Stability 6.3 (2010): 156-68. Web.

15 Mar. 2017. <http://dx.doi.org/10.1016/j.jfs.2009.05.006>.

Wang, Chunyang. "Bailouts and Bank Runs: Theory and Evidence from TARP." European

Economic Review 64 (2013): 169-80. Web. 15 Mar. 2017.

<http://dx.doi.org.librarylink.uncc.edu/10.1016/j.euroecorev.2013.08.005>.