Magazine | February 11, 2013, Issue


Bailout Facts

Mark Calabria’s “An End to Bailouts” (January 28) contains some interesting points, but it also contains a number of errors that substantially weaken the reliability of Mr. Calabria’s advice:

1.) Mr. Calabria decries the use of various government programs for bailouts, in particular the Treasury Department’s Exchange Stabilization Fund, which, as he says, “was used to back the mutual-fund industry. During the Clinton administration, when Timothy Geithner directed the fund, the Treasury used it to protect Wall Street investments in Mexico.” He argues that “the fund should be eliminated or, at the very least, its use should be restricted.”

Mr. Calabria should take solace in the fact that this has already been done. The Emergency Economic Stabilization Act (the law that enacted TARP) expressly prohibits the government from using this fund to bail out money-market funds. And Dodd-Frank sets forth specific mechanisms that in the future must be used for the funding of orderly liquidations and expressly prohibits using other means to fund such liquidations.

2.) In criticizing the scope of the Fed’s lending powers, Mr. Calabria states that “the Fed essentially has complete discretion in setting the terms of its 13.3 assistance [i.e., its unconventional loans in “unusual and exigent circumstances”], allowing it to save some parties while letting others fail.”

This is no longer true. Dodd-Frank limits the Fed’s ability to perform the types of emergency actions it performed in 2008 and afterward. The Fed is still allowed to set up lending facilities in certain situations, but it must clear numerous procedural hurdles before doing so. Moreover, the Fed is now permitted to offer such lending facilities only to entire classes of institutions; it is expressly forbidden to use its extraordinary-lending authority to lend to an individual entity outside of the orderly-liquidation process. It thus is simply untrue that the Fed has “complete discretion” to “save some parties while letting others fail.”

3.) In arguing against expanded deposit insurance, Mr. Calabria states: “The run on mutual funds in 2008, to the extent there was one, was caused by an unlimited extension of deposit insurance under the Transaction Account Guarantee Program. As TAG offered businesses and high-wealth households a federal guarantee, they shifted their money out of mutual funds and into banks.”

It is true that money-market mutual funds — which hold only 20 to 25 percent of all mutual-fund assets (and are the only type of mutual funds for which insured bank accounts are a viable alternative) — suffered outflows of over $1 trillion in 2009–10, and that TAG was likely a contributing factor. However, these outflows amounted to less than the inflows such funds had enjoyed in 2007–08, which totaled over $1.2 trillion. The inflows were likely due to the “flight to safety” stemming from the acute crisis of 2007–08, and thus were naturally unwound as the crisis abated. Accordingly, it is wrong to attribute those outflows primarily to TAG.

More important, those outflows can in no way be characterized as a “run” on such funds: The outflows bore no resemblance to the sudden mass of withdrawals that characterizes runs. The only run on funds occurred following the Reserve Primary Fund’s “breaking the buck” in September 2008, and that preceded the enactment of TAG. The government’s guarantee program for money-market funds, announced a few days later, did in fact end that run, as documented in the President’s Working Group Report on Money Market Fund Reform, published in October 2010.

4.) Mr. Calabria argues: “Another justification for government intervention in the financial sector was the ‘breaking of the buck’ by money-market mutual fund Reserve Primary — that is, the dropping of its net asset value below the par value of $1.00. The potential for widespread losses in other money-market funds raised the specter of bank-style runs among mutual funds. But Reserve Primary was heavily invested in Lehman debt; its losses were the result of a bad bet, not a run on mutual funds of a kind the government should offer protection against. Investors in Reserve Primary have recovered 99 cents for every dollar of investment — hardly a loss justifying a host of government interventions.”

The government did not guarantee money-market funds to stem the losses of investors in the Reserve Primary Fund; rather, it did so because the breaking of the buck set off a panic. The announcement of losses at the Reserve Primary Fund didn’t “raise the specter of bank-style runs” at other funds: It caused such runs to occur. About $310 billion was withdrawn from prime money-market funds during the week of September 15, 2008, according to the President’s Working Group Report cited above. It is reasonable to say that investors should not have withdrawn so much money at once simply because the Reserve Primary Fund had broken the buck, but the fact is that they did, and the government had no choice but to guarantee the funds. And as noted above, that guarantee worked to stop the run.

Mr. Calabria does his arguments no favors by distorting the circumstances surrounding prior government interventions in the financial system. A serious argument against such interventions needs to grapple honestly with these circumstances.

Jeremy Senderowicz

Attorney, Dechert LLP

New York

The views expressed above are not necessarily

those of the firm or any of its clients.

#page#Mark Calabria replies: Mr. Senderowicz claims to have identified “errors” in my piece. None of these are factual errors. They are differences of opinion and misunderstandings of the points I made.

In my discussion of the Treasury’s Exchange Stabilization Fund (ESF), I explained how the ESF was the vehicle for the government’s backing of the mutual-fund industry. Mr. Senderowicz points out that Congress has since banned the use of the ESF for backing mutual funds. I take no solace in this, however, because the ESF may still be used to back everyone else. My piece was not simply about ending bailouts of mutual funds; it was about ending all bailouts. Mr. Senderowicz confuses the example for the principle.

Mr. Senderowicz goes on to repeat the oft-heard claim that Dodd-Frank ends bailouts. But it is only once a financial institution is in receivership — that is, placed under the control of the government — that it has to be liquidated and that no taxpayer funds may be used for its benefit. Institutions that have not been placed in receivership may still receive assistance.

Further, one would think the recent experience with Fannie Mae would help Mr. Senderowicz and others understand the limitations of receivership. Fannie Mae is a prime candidate for placement in receivership — imposing an orderly liquidation would protect taxpayers — but this has yet to happen. Also, under Dodd-Frank’s liquidation authority, creditors may still be rescued, so long as the financial-services industry is required to foot the bill. While an improvement over the taxpayer’s footing the bill, this is still a bailout.

Mr. Senderowicz claims that Dodd-Frank ended the Fed’s practice of picking winners and losers under its 13.3 powers; now, he says, the Fed must offer lending facilities to entire classes of institutions. In my seven years on Capitol Hill, I have read many a provision of law that was drafted to be “generally available” but in reality would affect only one entity. As a practicing lawyer, Mr. Senderowicz must recognize how easy it would be for the Fed to craft “generally available” assistance that in truth was targeted at only one firm — and regardless, generally available bailouts are still bailouts. Yes, they are less unfair, but the moral hazard created is the same, if not worse.

In discussing events surrounding the fund Primary Reserve, Mr. Senderowicz again misunderstands my point. I never claimed the rescue was only of Primary Reserve. The point was, as he says, to stop a perceived panic. Yet as data released by the Investors Company Institute demonstrate, investors were shifting funds within the industry in the immediate aftermath of Primary Reserve’s breaking the buck — this is hardly evidence of a run. One man’s run is another’s market discipline; to say that my argument is based on an “error” is disingenuous at best.

In trying to split hairs, Mr. Senderowicz misses the overall point of the piece.


The color key to the graph accompanying Kevin A. Hassett’s article “The Progressive U.S. Tax Code” (January 28) contained an editing error: Green and blue were transposed.

Members of the National Review editorial and operational teams are included under the umbrella “NR Staff.”

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