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Financing Failure: A Century of Bailouts.

Financing Failure: A Century of Bailouts. By Vern McKinley. (Oakland, CA: Independent Institute, 2011. Pp. xvi, 381. $16.95.)

A common narrative from the financial crisis of 2008 is that the federal bailout of the major banks was essential to prevent an unprecedented collapse of the markets and potentially a second Great Depression. Vern McKinley, a Research Fellow at the Independent Institute, questions these assumptions in this examination of bank bailout policy. His analysis, which relies heavily on recently obtained Freedom of Information Act documents, portrays a panic-driven policymaking process in which officials made decisions based on false assumptions, incomplete information, seat-of-the-pants analysis, and the desire to "do something." Ultimately, McKinley concludes there is little evidence to justify the bailouts and contends that the only prudent course of action is for policymakers to allow institutions to fail, no matter their size and complexity.

Historically, when a bank became insolvent, regulators would close it and, if necessary, pay off insured depositors. In 1974, a different resolution process was used in which a troubled bank was "propped up" with a bailout. The rationale for bailouts was that some banks were "too big to fail" and had to be saved in order to prevent disruption of the broader financial markets. Although there was no direct evidence that a large bank failure would in fact produce such dire consequences, by 2008 "too big to fail" was accepted policy and used by regulators to justify nearly all major policy decisions that year. These included the bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and AIG and the creation of the Troubled Asset Relief Program, which ultimately made equity infusions to more than three hundred banks.

McKinley finds fault with the concept of bailouts and especially questions their need in 2008. He notes that assisting troubled institutions and preventing them from failing has the unintended consequence of encouraging moral hazard and limiting the ability of the free market to discipline lenders. He also contends that the doomsday scenarios underlying "too big to fail" were used to scare people into action, and he cites how the failure of Lehman Brothers and Washington Mutual did not result in the predicted financial contagion. He is especially critical of a pervasive "not on my watch" attitude among top officials that often resulted in policies that ended up sending mixed signals to the markets and even made the crisis worse.

Financing Failure provides a unique perspective on a flawed policymaking process and will be best appreciated by those who already have a good understanding of the 2008 financial crisis. McKinley makes a strong case that bailouts are not an optimal solution, but his conclusion that all failed institutions should simply be closed (though intellectually satisfying to believers in free markets) is politically naive. Few elected officials would be willing to risk the consequences of inaction, especially if the worst case scenario were to come true. Still, it is abundantly clear that regulators and politicians need to reevaluate the idea of "too big to fail" and above all be accountable and responsible for their actions.

David L. Mason

Georgia Gwinnett College

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Author:Mason, David L.
Publication:The Historian
Article Type:Book review
Date:Sep 22, 2013
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