Government rescue steps may have worked but at big cost

WASHINGTON -- After a year of costly government bailouts and public distaste for more, the government's response to the next company deemed "too big to fail" could be -- another bailout.

President Barack Obama warned Wall Street this week not to take risks on the assumption taxpayers will be there to "break their fall" the next time those bets turn sour. But, in fact, not much has happened this year to suggest that the federal government won't keep serving as a rescuer of last resort for giant financial institutions.

One solution would be new regulations that would prevent companies from getting into trouble and needing government help. But a regulatory overhaul first proposed by the Obama administration in March is bogged down in Congress.

America has long been a rescue nation. Over the years, taxpayers have saved airlines, railroads, a defense contractor and New York City. During World War II, it seized coal mines, Midwest trucking operators and many other companies and even, briefly, retailer Montgomery Ward. The pace has picked up in the past 12 months: Chrysler's second rescue and General Motor's first, the bailout of the world's largest insurance company and, of course, the rescue of institutions whose collapse might topple the financial system.

The recent bailouts were necessary to avoid a collapse of the U.S. and global economies, says Ben Bernanke, who was recently selected by Obama for a second four-year term as chairman of the Federal Reserve. Still, he says he had to "hold my nose" over them.

Today, polls show strong public distaste for bailouts, and politicians from the White House to the Capitol are saying "no more." The administration made room in its budget for an additional $250 billion in bailout assistance but later dropped that idea as unnecessary. Given the highly charged atmosphere in Congress, more bailouts were unlikely anyway.

"You don't want anybody to plan a strategy on the fact that they're sure they're going to get bailed out," says Dan Seiver, a finance professor at San Diego State University. He says breaking up companies deemed too big to fail, as some have suggested, would be an overreaction, but that an orderly mechanism needs to be in place "so that when it's time for them to fail, they do fail."

But there's nothing in the Obama plan that would prevent future government takeovers. Instead, it would establish new consumer protections against potential bank collapses and set up a special category for "systemically important banks." The focus is on heading off future meltdowns that would necessitate bailouts in the first place.

Obama went to Wall Street on Monday to try to revive interest in his plan and to urge its congressional passage this year.

House leaders have expressed optimism of doing that, but Senate leaders are less certain. The bill's proposal to give the Fed more power to regulate large financial conglomerates has generated opposition, including from Senate Banking Committee Chairman Chris Dodd, D-Conn.

Meanwhile, the biggest banks are getting bigger, thanks to mergers and last year's failure of Lehman Brothers. And they still make bets that, in the aggregate, are worth far more than the capital they have on hand to cover against potential losses.

Even without new laws, there are moves to at least soften the impact of future crises.

Treasury Secretary Timothy Geithner and several other finance ministers are pushing for new international rules for banks with global reach, including a requirement for larger, higher-quality capital reserves to serve as a cushion in future crises. But actually coming up with such rules is expected to be difficult. Leaders of the world's 20 top economies are expected discuss the issue at a meeting next week in Pittsburgh.

In addition, the steps taken last fall by the Federal Reserve and the Treasury Department have helped to shore up bank balance sheets, reducing the likelihood of additional bailouts in the coming days. So-called "stress tests" on major banks helped restore confidence by showing greater financial health among most big banks than expected. Some banks also were required to raise more capital.

Taken together, these steps "will stand the test of time as a very impressive response to an unprecedented crisis," says David Jones, chief economist at the consulting firm DMJ Advisors and a former Fed economist.

But some economists suggest Washington put taxpayers at too much risk -- and pumped far too much easy money into the system, setting the stage for staggering budget deficits and sky-high inflation.

Money manager Peter Schiff, a critic of Washington's handling of the crisis, said Bernanke and other policy-makers may have helped ease the pain of the downturn "but the consequences are much more pain down the road.

"We're in worse shape now than before the crisis, deeper in debt," says Schiff, president of brokerage Euro Pacific Capital based in Darien, Conn. "We should have let more institutions fail."