Why Federal Reserve Support Is Really a Bailout

Photo
A vehicle comes off the line at General Motors plant in Lansing, Mich.Credit Jeff Kowalsky/European Pressphoto Agency

It has become something of an article of faith in the financial world that government support like discount-window liquidity does not count as a bailout. Namely, the argument is that if a financial institution needs to borrow some money on a short-term basis from the government, but the institution is otherwise solvent, that the lending is not a bailout.

But is that right?

Other debtors don’t get a special government-provided backstop lender. If a consumer finds herself a bit short some month, and the credit card company won’t lend anymore, there is no office of the government one can go to for a short-term payday loan on reasonable terms.

If a corporation faces a liquidity crunch, and can’t find a debtor-in-possesion lender who is willing to finance a reorganization, the Fed does not provide a special government loan. Well, with two notable exceptions that is – but I doubt anyone would deny that the cases of General Motors and Chrysler were not bailouts.

Now there are good policy reasons to provide a large financial institution with short-term lending if it is solvent but suddenly illiquid. Among other things, doing so prevents a good deal of collateral damage to the broader economy.

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Indeed, that is also the reason it probably made sense to make D.I.P. loans to General Motors and Chrysler, too.

But good policy is not necessarily consistent with a pledge of “no more bailouts.” And if we are running the risk of more bailouts, that provides a much stronger justification for preventive regulation.

Hence the problem.

And hence the reason the financial industry really wants to say these short-term loans are not bailouts. The trick is to not simply accept that argument at face value.