To death and taxes, Americans can add a third inevitable thing -- bank failures. The primary reason that U.S. bank failures are so unavoidable is that these institutions can lend out their government-insured deposits to just about anybody for a range of purposes -- the most commonly disastrous of which is to buy or build real estate. When borrowers can't repay the money, the bank goes down, and the Federal Deposit Insurance Corporation steps into the breach -- except when the bank that made the bad loans is deemed too big to fail.
Given the level of public outrage over the government's rescue of banks during the recent financial crisis, the final cost to the taxpayer of keeping those failed institutions afloat turns out to have been relatively modest. According to The Wall Street Journal, the FDIC has paid out a mere $8.89 billion to 165 banks since the financial crisis began. As I learned when I was a consultant for the FDIC in 1982, those payments are part of the FDIC's program of encouraging healthy banks to acquire failed ones. This actually helps the FDIC recover some of the money it pays out to keep depositors whole, by liquidating the failed bank's loans.
Admittedly, that $8.89 billion figure doesn't encompass the real total cost of the bank rescues, because the FDIC wasn't the agency that rescued the "too big to fail" institutions. That's where the $700 billion Troubled Asset Recovery Program came into play. But it turns out that TARP, too, cost far less than expected. According to the Congressional Budget Office, the ultimate tab for TARP is likely to come in at $25 billion. By comparison, that's about 11% of the $220 billion price tag attached to the S&L Crisis of the early 1990s, when 2,100 savings & loans failed in the wake of that industry's deregulation. That $25 billion also amounts to just 7% of the CBO's original TARP cost estimate of $356 billion.
Does this mean that the free market works and we should stop trying to regulate the financial system? Not at all. For example, the FDIC's role in bailing out bankers' bad bets means that the financial industry is only a free market if you define "free market" as, "heads Wall Street wins, tails the taxpayer loses." In my view, a true free market would make Wall Street pay for its bad bets rather than shifting the pain of the losses onto the general public.
How the FDIC Gets Good Banks to Rescue Bad Ones
The FDIC's $8.89 billion in bailout costs came through a specific arrangement called loss-sharing: The FDIC encourages a relatively healthy bank to take over a failing one by agreeing to reimburse the rescuer for some of the losses it will incur when it tries to turn the failed bank's bad loans into cash.
The FDIC has inked such loss-share deals with 236 financial institutions -- agreeing to cover losses on $160 billion of assets, according to The Wall Street Journal. The FDIC forecasts that it will ultimately pay out more than twice what it has spent so far for these agreements. Specifically, it expects to pay out another $21.5 billion from 2011 through 2014.
When we compare the costs of rescuing the world from the financial crisis to the cost of saving the United States from our S&L debacle, it looks like we've gotten much better at cleaning up the messes bankers leave behind them after they collect their hefty compensation packages. But if you take into account the $12.8 trillion in U.S. government guarantees and cash, the $23 trillion in lost stock market value, the $14.2 trillion national debt, the $1.5 trillion federal budget deficit, and the 14 million unemployed Americans -- all of which can be traced, in part, back to the recent financial crisis, the cleanup costs don't look so small.
The Dodd-Frank Act that was intended to reform Wall Street enshrined the conditions that caused the financial crisis rather than eliminating them: It created a mechanism to rescue banks that are deemed too big to fail; did nothing to change a Wall Street compensation system that rewards closing big deals fast and ignores the cost of their failure; failed to set specific limits on borrowing too much money; and preserved the ability of Wall Street firms and other public companies to write their own report cards.
Wall Street contributed $5 billion to Washington politicians and lobbyists between 1999 and 2008, and as a result, we have the best system money can buy -- a "free market" that gives Wall Street the profits from its short-term bets and shifts the longer term losses onto the taxpayer. Yes, the cost of rescuing the financial system from the financial crisis was lower than was originally expected. But unless we change the conditions that led to the crisis in the first place, we'll pay even more the next time around.