The Principles of Macroeconomics
Abstract
To stabilize the economy and restore economic growth during the Great Recession, the US government has implemented the bailout plan to purchase toxic assets, inject capital into distressed financial institutions and recapitalize non-bank lenders. There is no common view on the bailout outcomes for the economy. As the result, the need for bailout became the heated debate among the government officials, financiers and economists. The opinions differ widely on the necessity of bailout and its impact on the financial system and economy.
Key Words: bailout, financial institution, financial crisis, credit freeze, taxpayer.
PRINCIPLES OF MACROECONOMICS
The Great Recession emerged in the mid-2007 with the bursting of the housing – bubble and subprime mortgage crisis. Many financial institutions had toxic assets on their balance sheets and significantly lacked liquidity to meet their obligations in time. As the result of financial instability, the US GDP began to shrink, unemployment rate was rising and large banks and corporations collapsed. For example, large investment banks, such as Bear Sterns, Merrill Lynch, and Lehman Brothers, became insolvent. To respond to the financial crisis, the US government has initiated $700 billion bailout plan, known as the Troubled Asset Relief Program (TARP). (Goolsbee, Krueger, 2015). The program was authorized under the Emergency Economic Stabilization Act in October 2008. The major goal of the program was to purchase toxic assets and equity from financial institutions, as well as recapitalize non-bank lenders.
The TARP has sparked a heated debate about the advantages and disadvantages of bailouts of distressed financial institutions and corporations. Opinions differ widely on the bailout effectiveness in restoring economic growth and creating incentives for investors. Many economists and policy-makers argue that bailout encourages risky behavior of financial institutions and subsidizes them through taxpayers’ money (Taibbi, 2013). In addition, by insulating financial institutions from the adverse effects of over-risky operations and poor risk management practices, the government distorts the incentives for fair and transparent business practices. However, the government inactivity might have resulted in more severe economic meltdown and higher losses for taxpayers and investors.
The major advantages of the bailouts of investment banks and corporations in response to the Great Recession include restoring investors’ confidence and wellbeing, encouraging economic growth, preventing bankruptcies, safeguarding jobs across the economy, preventing credit freeze, and restoring liquidity of financial institutions. However, most of advantages are effective in the short run, unless the companies are able to design and implement programs to enhance their viability.
The largest financial institutions in USA, including Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, Merrill Lynch, and AIG, collapsed. By purchasing the “toxic assets” from financial institutions, the government improved their balance sheet positions and stopped other institutions from toppling. Subsequently, most of distressed institutions were either acquired by another companies or nationalized. In addition, the government prevented bank panic, which might have devastating effect on economy. Another short – run advantage is prevention of the credit freeze. Bailouts helped banks to make credit available to other banks. Otherwise, most banks would stop lending …
