In recent years we have gone through one of the great financial meltdowns. It was a disaster for everyone but as usual the greatest pain and suffering accrued to those on the bottom because they have the least in reserve against hard times. That such a thing should not be allowed to happen again is something we all agree on, but unfortunately figuring out how we should respond is beset with misunderstanding and confusion.
The standout example of how much people misunderstand the financial crisis is the fate of the money the US government invested in saving banks and insurance companies. A lot of people, even people that generally I consider really informed, seem to be under the impression that governments just handed billions and billions to bankers and all that money vanished into executive bonuses and investor dividends. It just isn't true, and understanding how these things unfolded is key to figuring out how, when, and if the government should preform such rescues in the future.
I am reading a book about Ben Bernanke entitled The Courage To Act, which describes in detail what Bernanke did throughout the crisis as the leader of the Fed in the US. For example, when AIG was running out of liquidity and on its way to failing the Fed gave it a $85 Billion dollar loan.
That wasn't a gift. It was a loan at an exorbitant interest rate. Part of the condition for getting the loan was that the government took over 80% of AIG.
A few years later the Fed had the loan repaid entirely and it had resold the stock of AIG, netting a tidy profit of $23 Billion.
Profit, not loss.
The financial system was protected from a potentially catastrophic loss, and the Fed *made* money. Of course part of the desired outcome is that the people who made terrible decisions suffer for those decisions. The company couldn't simply be handed money to make up for its idiocy and hubris, and it wasn't. The investors lost nearly everything, so anyone thinking to do such things in future could be reasonably sure that if things go bad they stand to lose 95% of their investment when the government chooses to step in... hardly a comforting thought.
This sort of resolution is by far the standard in government interventions of this type. There have been many times in the past that governments have stepped in to hand huge chunks of cash to big companies that are failing and this is the standard story. Normally the government gets its money back, usually with a profit. Not a big profit, mind, but when stabilizing a disastrous situation and preserving major employers you don't have to make much of a profit before it is worth it.
Clearly we don't want the government to be giving money to banks, and it is incredibly galling when executives of a failing bank that required a bailout collect huge bonuses. That said, when we are faced with a potential catastrophe I definitely want the government to act as a last resort to keep things from tipping over into disaster, especially because history tells us that when they do this it is primarily wealthy investors who take a bath and average employees who benefit.
I should note that not all government interventions went well. Irish banks did some really dumb things and their government foolishly and without decent information decided to guarantee their creditors against loss. That was a colossally foolish move, made in haste, and it cost them dearly. Not all interventions are sensible, but when speaking of them it is critical to understand the difference between the best case and the worst, and why it is sometimes (not always!) right to step in and bail people out.
By far the better solution to the problem is to do things like we have in Canada, which is to have strong government regulations on banking to keep them from doing stupid things and getting themselves into serious trouble. That worked during the recent crisis and it should be the standard going forward. Deregulation just invites people to do more stupid things that risk everybody else's security. But when disaster does come, and it will, we have to be ready to support the government when it steps in to block the leak in the dam. Of course the fools who created the leak should be made to pay, but them paying is exactly what happens. Let us not be so eager to spite the bankers that we end up watching the dam explode and drown us all.