barry-ritholtz-bailout-nation-cropped.thumbnail.jpgIn Bailout Nation, econoblogger and analyst Barry Ritholtz asks how America turned into a country where those who don’t manage risk properly are bailed out from the consequences of their own decisions and stupidity.  Clocking in at 300 pages, the answer isn’t short, but Ritholtz’s combination of wit and clarity makes the book an enjoyable read.  I’ve gone through a number of books on the crisis, and this one is the clearest and easiest to understand, yet it remains accurate.  Ritholtz keeps it simple, but he doesn’t oversimplify.

I’ve been following this crisis for, well, long before it existed, at least as far back as 2002 (when it became clear Greenspan’s policies would lead to a housing bubble).  I’d say I know a fair bit about how the crisis came to be, but Bailout Nation had a number of insights and many facts I wasn’t aware of.  

Perhaps the best thing about Ritholtz’s narrative is that Barry puts current events in context.  Not only does the book have a brief history of the central banks in America, it runs through the New Deal, the post war period and deals with past bailouts.  Ritholtz notes that the era of bailouts actually started in 1971…

The rescue of Lockheed in 1971 ($250 million) led to loan guarantees for Penn Central in 1974 ($676.3 million in loan guarantees), which paved the way for the $1.5 billion rescue of Chrysler in 1980 and then Continental Illinois Bank in 1984 ($1.8 billion loss). This led to the original mother of all government insurance payouts—the savings and loan (S&L) crisis of the early 1990s (total taxpayer cost: $178.56 billion), which led to the stock market rescue of 2000, and so on.

Now that may strike some as a big claim.  That’s where Ritholtz’s review of the New Deal comes in.  Because here’s the odd thing—the New Deal didn’t include bailouts.  Yes, the New Deal helped people who needed it, and even helped corporations; but it did not seek to bail out specific corporations from their own failures.  

Traditional American style intervention in the economy wasn’t about bailing out failures…

Instead the government would give new industries a great deal of help (for example, huge amounts of land to railways) and then let them fight it out.  During the "hockey stick" phase of a new technology many firms arise, and compete.  They create too much capacity, and eventually there is a shaking out.  During that shaking out, when prices collapse, most firms fail, and only a few survive.  The government did not bail out the losers.

Most recently you can see this in action in the dot-com boom, bubble and bust.  Most dot-coms didn’t make it, and that’s the way it should be.

And in bad times, when the government helped, it was to help those who were effected by problems, like the Great Depression, not of their own making.

But since 1971, and more specifically since the ascension of Alan Greenspan to the chairmanship of the Fed, that changed.  The Wall Street term was "the Greenspan Put".  As Ritholtz explains, a put is the option to sell a stock at a specific price.  No matter how low the stock price goes, you can always sell for the strike price of the put.  And for the better part of two decades, every time the markets seemed to be in danger of declining, Uncle Alan Greenspan, would step in and provide easy money to try and stop it from doing so.  More than that, he provided easy money to create bubbles – the stock market bubble in the 90s, then the housing bubble in the 00′s.

Add to Alan’s easy money a refusal to engage in regulation of markets, a belief that the government would always step in to fix market failures when things went wrong (as with Long Term Capital in the 90′s), compensation practices which encouraged a short term profit motive (so executives could cash in their stock options) and much more which I lack the space to go into (but which Ritholtz deals with in style in the book) and you came to the current crisis, where 15 trillion has been committed by the Federal government to make good the losses of private financial actors. 

How, exactly, the US went from a nation which believed that companies, including their stockholders and bondholders, which failed, should suffer the consequences, to a Bailout Nation is thus the central question of the book.

But it’s not the only question.  Perhaps the more important question is "what are the consequences of constantly bailing out private companies which are responsible for their own losses?"

The answer, according to Ritholtz, is that each bailout sets up the next. 

The reason is moral hazard.  If you know that if you fail, you’ll be bailed out, you take more risk.  Heads you win, tails the taxpayers lose.  The executives who oversaw the creation of the current crisis, after all, are still very very rich.  They did fine.  And the bondholders who loaned them the money have mostly gotten by.  Certainly there have been some losses for private investors, but compared to what they would have been without bailouts they aren’t that significant.  Especially if you made your millions in the good times.

Which leads to something Barry doesn’t say in the book, but which follows logically from his argument.  If bailouts lead to more bailouts, well, this isn’t the last bailout.  There’ll be another crisis, and it will be even bigger.  (I’ll be curious to see if Barry agrees with this.)

None of this does real justice to Barry’s book.  There are sections on the legislative changes that allowed this to happen.  There is a discussion of the role of the SEC and other regulators.  There are concrete suggestions for how to deal with the crisis without creating so much moral hazard.  Perhaps most importantly there is a discussion of the fallacy of self-regulating markets, epitomized by this quote:

The misguided deification of markets is the primary factor that led us to being a Bailout Nation. Markets can and do get it wrong—not by just a little, either; occasionally they can be wildly wrong.

At the end of the day, if you’re going to have radically deregulated markets then you have to allow actors to take their losses.  As Ritholtz points out, the way markets self-regulate, to the extent they do, is for firms which don’t manage risk to go out of business and for people who gave those people money to lose that money.  The lesson taught by markets is that stupid money is dead money.  

Unregulated markets where you don’t allow companies and individuals to be destroyed by the losses they have desperately earned have neither the virtues of markets nor of regulation.

If you’re looking for one book which explains what went wrong, I haven’t read a better one than Bailout Nation.  It’s an easy, colloquial read, simple to understand,  and yet doesn’t oversimplify.  

Please welcome Barry Ritholtz to Firedoglake.  As usual with book salons please take off topic conversations to the prior thread.