Botched Bailouts

I've been following the government's many recent financial bailouts (Fannie and Freddie, AIG) and interventions (Term Lending and Auction Facilities, short selling rules, RTCII) fairly closely.

There has been much discussion of how deregulation of the financial industry lead to this crisis - especially in the case of the (former) five firms that 'enjoyed' net capital exemptions from the SEC - and how the government's recent actions smack of socialist policies.

Until Friday, I had not read anything about how these actions may have exacerbated the financial crisis. Jim Jubak does a superb job of outlining how these rescues have actually made some things worse. The whole article is worth reading, but the highlights are below.

[I]n the name of creating an orderly liquidation of a company such as Lehman Bros., they create a mad scramble to get paid before the bankruptcy court can act.

By wiping out the Fannie Mae and Freddie Mac preferred stock, the Fed and Treasury killed off any possibility that some other financial institution in need of capital could raise cash by selling these dividend-paying shares.

[T]he Treasury and Fed have ensured that no conservative, income-seeking investor in his or her right mind would buy preferred stock from a troubled financial company looking for capital.

After drawing a line in the sand and saying no more bailouts, the Fed and Treasury ponied up $85 billion in taxpayer cash to go into the insurance business. Their excuse for the about-face: Though the Fed had planned for a Lehman bankruptcy, it hadn't modeled a failure at AIG and couldn't predict the consequences of letting the company go into bankruptcy. That's not reassuring.

Source:
Botched rescues are killing markets
Jubak's Journal 9/19/2008 12:01 AM ET