What, No Lehman Aid?

Wall Street is consumed with the subject of bailouts. As analysts chewed over the implications of the government's decision to assume the debt of ailing mortgage giants Fannie Mae and Freddie Mac, traders (and their real-estate brokers) wondered whether erstwhile titans Lehman Brothers and Washington Mutual would be next in line for government assistance. Meanwhile, lobbyists for the big three automakers were refining their pitches for $25 billion in loan guarantees. It is sure to be another long weekend for Treasury Secretary Henry Paulson.

Bailouts—the government's stepping in and providing financial assistance or credit guarantees to private-sector companies—are a highly confusing subject. As policymakers hasten to save some companies from the ravages of creative destruction, they leave others to fail. Some 5,644 businesses went bankrupt in July, up 80 percent from July 2007. So are there some objective criteria we can use to determine whether the government will toss a lifeline to a particular company?

Recent history offers some hints. A sole proprietor or a homeowner? Forget about it. A small, privately held business that runs into a spot of trouble? No soup for you. A debt-ridden bedding retailer like Linens 'n Things or a purveyor of potato skins like Bennigan's? No 'n No.

Clearly, financial firms get extra consideration. But being involved in the money trade is no guarantee. As of last Friday, 11 (mostly small) banks have been allowed to fail this year.

It's a truism that the bigger you are, and the more you owe, the more forbearance you're likely to get. In 1984, when Continential Illinois, whose reckless lending practices had catapulted it into the ranks of the nation's 10 largest banks, ran into trouble, the government bought some of its loans and provided extraordinary compensation to depositors. "We have a new kind of bank," complained Fernand St. Germain, a congressman from Rhode Island, "It is called too big to fail." (St. Germain, who shepherded the bill that deregulated the savings-and-loan industry, would be blamed in part for the record-setting bailout of S&Ls later that decade).

But these days, size alone doesn't matter. Earlier this decade, Enron, WorldCom, and Global Crossing, three gargantuan companies, went bust while the government looked the other way. Of course, when the aforementioned companies filed for Chapter 11, nobody lost electricity or was unable to make a phone call. "But if the government envisions that a failure will have a serious adverse consequence on the economy, it's going to step in," said Benton Gup, a professor of banking at the University of Alabama and editor of the collection Too Big To Fail: Policies and Practices in Government Bailouts.