Long history of government bailouts

The US crisis is nothing new: administrations in Europe and emerging nations have stepped in to rescue troubled banks, writes Patrick Honohan

NATIONALISATION, BAIL- OUT, shotgun merger, bankruptcy. The failures and near failures of big financial institutions in recent days have certainly been dramatic.

Because they are occurring in some of the largest economies in the world, the sums involved are eye-popping and well-reported.

They will have far-reaching effects. The financial engineering that has been involved is unprecedented in its complexity, but the costs have not been unprecedented. One does not have to go back very far in history to find events of comparable magnitude.

Over the past decade, for example, the Chinese government has injected about $350 billion (€243.5 billion) into China's largest banks. Although the fact was never explicitly acknowledged, these banks were deeply insolvent in the late 1990s because they kept lending under political pressure to non-viable firms in declining industries. (The banks too were state-owned.)

The sum required to recapitalise them far exceeds the total of the US Federal Reserve's lending to distressed institutions in the current crisis. The Chinese injections were not just loans, but represented a net cost to taxpayers.

How could insolvent Chinese banks have survived for years, when US banks can't last a week if doubts about their solvency catch hold? Simply because the Chinese depositors knew the government would stand behind the banks.

One intriguing factor is the degree to which governments all over the world tend to step in to protect ordinary depositors of the commercial banks during systemic crises.

Over the years, there has been a bit of a US-European divide on this, which partly reflects the large number of banks - more than 7,000 - in the US and the scale of the deposit insurance there. The first $100,000 of US deposits is fully covered.

While there is a semi-official presumption that some US commercial banks are "too big to fail", the authorities have no compunction in letting large depositors take losses in smaller banks.

IndyMac Bank in California, which failed a couple of months ago, had about $1 billion of uninsured depositors who will lose 20-50 per cent of their (large) deposits in the liquidation, whereas anyone with a deposit of less than $100,000 was covered.

Deposit insurance in most European countries is on a much more limited basis (under the EU deposit guarantee schemes directive, EU banks must provide deposit cover of at least €20,000).

Nevertheless, even large depositors of failing European banks have tended to be protected.

In Denmark, Norway, Sweden and Finland during the late 1980s, the governments nationalised large segments of their banking systems that had got into trouble with unwise property lending. Depositors were unaffected, the banks were cleaned up, turned around and sold back into private ownership over the following years.

Taxpayers took a hit - but not as much as had initially been feared, because the property market turned up again and the government was able to sell the repossessed properties well. (Swedish taxpayers may even have made a profit on the whole business.)

The largest single-bank bailout in Europe was the 1993 rescue of Crédit Lyonnais, which is said to have cost French taxpayers some $25 billion. At the start of the current crisis in mid-2007, two small German banks, Sachsen and IKB, were also bailed out with government money. (Sachsen is of local interest, in that the losses there were chalked up by its Dublin-based subsidiary.)

Admittedly, the British authorities did not compensate depositors of the sprawling and shady BCCI or of Barings when they failed in 1991 and 1995 respectively, but these were isolated incidents presenting no threat of contagious panic, unlike Northern Rock which, after a bit of a dither, the British government nationalised.

Even governments in developing nations have tried to protect their depositors at enormous costs. China is a special case, but the scale of its banking failures - in relative terms - have been matched over the past few decades by collapses in Indonesia, Argentina, Nigeria and Bulgaria.

In the end though, a banking crisis in a small, poor country can be too big for its government to absorb. In such countries, investors become nervous not just about the banks but about the government's solvency and the likely inflationary consequences of the banking bailout.

That's one reason why banking and exchange rate crises have often gone hand-in-hand, one feeding off the other. At least we can no longer have that problem in Ireland.

A boost to interventionism this time around is the fact that the chairman of the Federal Reserve, Ben Bernanke, made his considerable academic reputation with a detailed analysis of the great depression, in which he showed that that downturn was greatly exacerbated by the credit crunch caused by the wave of bank failures of the early 1930s.

His hypersensitivity to this issue helps to explain the relatively accommodating approach adopted by the US authorities and their willingness to make large loans to institutions that may not be able to fully repay them.

Not everyone has been bailed out in these rescues. Shareholders appear to have been almost wiped out in every case where government rescue money has been committed. And Lehmans - an institution without retail depositors - has been left to the bankruptcy courts, despite the complexity of the fallout and the losses that its failure is imposing on countless other banks and funds.

Bailouts can store up trouble for the future, encouraging even more reckless behaviour.

Arguably, governments step in too often, but their proclivity to do so allows depositors at household banks to sleep easier.

Prof Patrick Honohan is at the Institute for International Integration Studies at Trinity College Dublin