Another politicized contribution of capital involved GMAC, the financing arm of General Motors. GMAC was permitted to become a bank holding company so it could receive $5 billion in federal capital under the TARP program. Of course, that program was supposed to rescue financial institutions, not auto companies. But Congress refused to pass legislation authorizing additional capital contributions to auto companies.
Like GMAC, American Express and Discover Financial were allowed to convert into bank holding companies in order to receive billions of dollars of federal capital. Although it would have been unfortunate if either credit card company had become insolvent, were they too big to fail? Since they serve a highly diversified base of merchants and customers, the bankruptcy of either credit card company would not have caused the failure of many other financial institutions. Indeed, other banks would quickly have taken on the business from the merchants and customers of the failed credit card company.
In addition, Goldman Sachs and Morgan Stanley were allowed to convert quickly into bank holding companies and subsequently received $10 billion each in federal capital. There is considerable evidence that the short term liquidity of these two broker dealers was under heavy pressure, but this problem was solved when they became banks that could borrow easily from the Federal Reserve. There is little evidence that either Goldman Sachs or Morgan Stanley needed a large infusion of federal capital in order to survive.
By contrast, when Lehman Brothers asked to become a bank holding company to deal with the heavy pressures on its short term liquidity, this request was rejected by the federal regulators. Why? We don’t know. Similarly, why did the federal regulators decide to bail out Bear Stearns but not Lehman Brothers, which was twice as large? Although many have speculated on the answer, again we really don’t know.
In order to put some discipline into the process of bailing out financial institutions, Congress should pass a statute requiring the Secretary of the Treasury to explain in writing the rationale for every federal bailout. That explanation should contain an analysis of the costs and benefits of the bailout, which should be approved by the Chairman of the FDIC and the Federal Reserve. This explanation should be reviewed in light of the subsequent facts by the General Accounting Office, which should issue a public report on its findings. Only with such a procedure will we understand the criteria actually used in applying the vague doctrine of “too big to fail,” and begin to hold accountable federal officials for spending billions of dollars on bank bailouts.