The Mother of All Bailouts

Before the housing and credit bubbles popped, Barry Ritholtz, a lawyer turned blogger and money manager, was one of the voices crying in the wilderness. His caustic (and occasionally profane) blog, The Big Picture, dissected macroeconomic news and relentlessly cut through spin. His book, Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy (Wiley), takes a long view of the roots of the economic crisis, tracing the history of a series of ever more expensive taxpayer-funded bailouts of failed industries. He spoke with NEWSWEEK's Daniel Gross. A podcast of their conversation can be heard here. Excerpts:

Gross: Most people who talk about the first bailouts go back to the savings-and-loan crisis in the 1980s. But your book starts with a bailout of a nonfinancial firm in 1971. Tell us about Lockheed.
Ritholz: In 1971, it was the middle of the Vietnam War, and Lockheed was a major defense contractor that through a combination of bad planning and some strategic errors had overextended itself. Companies like this knew how to work themselves through the D.C. bureaucracy, and so they decided that rather than go through a Chapter 11 bankruptcy that they would ask for government-guaranteed loans. They originally asked for $600 million and ended up getting $250 million. It was unprecedented. The debate was raucous. And once this passed—and it just squeaked by—it really opened the doors for future bailouts. One of the themes you see every bailout is "this is critical," or "the system will fall apart if this dies." Lockheed was "a critical supplier of defense components." Chrysler was "a critical part of the national economy." If they were allowed to die, who knows what would happen?' Actually, we do know what would happen because companies die all the time; it's really not that big a deal. People move jobs, the suppliers readjust, and wherever we had excess capacity, it gets put to work more productively in another place.

The big change we get in the '80s is that bailouts go from being of old industries to the financial-services industry.
In the 1950s, manufacturing and heavy industry was about 30 percent of GDP, and when you looked at it as a percentage of the S&P 500 profits, it was very significant, and the financial services were 10 percent. Go forward half a century, and suddenly 21 percent or so of GDP is related to insurance, credit cards, mortgages, Wall Street, the whole banking sector. But the financial-services industry didn't really need Congress and politically elected people to do bailouts. It had the Federal Reserve.

You make an interesting point that Federal Reserve chairman Alan Greenspan had this tremendous belief in the power of markets to self-regulate because people were rational actors. And yet, you write that he was frequently reacting to psychology. How do you square those two?
Well, you can't. It's obviously a contradiction. Look, we know from the studies and the Nobel Prizes given out recently that human beings aren't extremely rational. We engage in all sorts of analytical foibles and errors, and our wetware is flawed. To his credit, Greenspan actually admitted there was a flaw in his philosophy. But history speaks for itself. But we had a huge amount of deregulation, repealing Glass-Steagall, done at the behest of Citibank, and the Commodities Futures Modernization Act, done at the behest of AIG and Enron.

The five biggest banks went to the SEC and got the limits on how much leverage they can use lifted. The idea was: we're big boys; we can handle this ourselves. And look what happened. The idea that people are rational, that even the best corporate executives at the biggest, wealthiest financial firms know what's in their own best interest, that's just false. We're slightly clever, pants-wearing primates. It's like taking a bunch of monkeys and putting a big pile of bananas in a room and saying, "Now, don't eat all the bananas. You need one a day for the next 90 days." Well, you come back three days later and there are no bananas left.

I don't know why this image of the monkeys with bananas makes me think of CNBC.
Unfortunately, some of the advice that has come from all the financial media has just not been cognizant of risk. There's an old quote that the role of the Federal Reserve is to pull away the punch bowl when the party is getting good. And the financial media—not across the board, I don't want to paint with too broad a brush, but somewhere in the neighborhood of 80 percent—was spiking the punch.