Building Better Bailouts: The Case for a Long-Term Investment Approach

Florida Law Review Volume 63 | Issue 6 Article 2 2-8-2013 Building Better Bailouts: The Case for a Long-Term Investment Approach Jeffrey Manns Follow this and additional works at: http://scholarship.law.ufl.edu/flr Recommended Citation Jeffrey Manns, Building Better Bailouts: The Case for a Long-Term Investment Approach, 63 Fla. L. Rev. 1349 (2011). Available at: http://scholarship.law.ufl.edu/flr/vol63/iss6/2 This Article is brought to you for free and open access by UF Law Scholarship Repository. It has been accepted for inclusion in Florida Law Review by an authorized administrator of UF Law Scholarship Repository. For more information, please contact . Manns: Building Better Bailouts: The Case for a Long-Term Investment App BUILDING BETTER BAILOUTS: THE CASE FOR A LONG-TERM INVESTMENT APPROACH Jeffrey Manns* Abstract The Article seeks to fill a crucial gap in the Dodd-Frank Wall Street Reform and Consumer Protection Act: the failure to create a framework for dealing with future financial bailouts. It argues that the federal government’s ad hoc, “break even” approach to the recent bailouts not only shortchanged taxpayers, but more importantly failed to provide deterrence against the type of reckless risk-taking that led to the financial crisis. This Article argues that the key to legitimizing future bailouts and limiting moral hazard is to institutionalize a long-term investment-oriented approach that delineates clear contours and conditions for aid. It calls for establishing an independent agency, the Federal Government Investment Corporation (FGIC), to serve as an investor of last resort, which would make bailout monies contingent on beneficiaries sharing both risks and long-term returns with taxpayers. The FGIC would establish express, ex ante conditions for providing aid that would temper corporate risk-taking, protect taxpayers, and establish bounds to bailouts. Tying government bailouts to shared sacrifices with managers, shareholders, and creditors of beneficiaries, proportional profit sharing with taxpayers, and corporate governance reforms would help to ensure that future bailouts serve a productive purpose. INTRODUCTION ................................................................................... 1350 I. NATIONALIZATIONS, FEDERALIZATIONS, BAILOUTS, AND WIND-UPS ............................................................................... 1356 A. The Inevitability of Government Intervention During Financial Crises ................................................................ 1356 1. Nationalizations and Federalizations........................... 1358 2. FDIC Wind-Ups .......................................................... 1362 3. The Challenges of Delineating Bailouts ...................... 1366 II. THE SHORTCOMINGS OF THE RECENT BAILOUTS ...................... 1370 A. The Troubled Asset Relief Program .................................. 1371 1. The Case of Goldman Sachs........................................ 1374 B. Assessing the True Costs of Bailouts................................. 1377 * Associate Professor, George Washington University Law School. I would like to thank many of my colleagues at the George Washington University Law School, as well as participants in the University of North Carolina Law School faculty workshop, for their thoughtful comments. I would also like to thank Carson Le and Rachel Zelman for their research assistance. 1349 Published by UF Law Scholarship Repository, 2011 1 Florida Law Review, Vol. 63, Iss. 6 [2011], Art. 2 1350 FLORIDA LAW REVIEW [Vol. 63 1. The Costs of Ad Hocery .............................................. 1379 C. The Shortcomings of the Dodd-Frank Act: The Bailout Gap .................................................................................... 1382 III. THE CASE FOR INSTITUTIONALIZING AN INVESTOR OF LAST RESORT .................................................................................... 1383 A. A Blueprint for the Federal Government Investment Corporation ....................................................................... 1384 1. Crafting an Investor Paradigm for the FGIC ............... 1384 2. The Natural Monopoly Analogy.................................. 1385 3. The Proportional Share Approach to Investing ........... 1386 B. Principles for Establishing a Bailout Framework ............ 1388 1. Deterrence of Each Level of Stakeholder to Mitigate Moral Hazard ................................................ 1388 2. Alignment of Interests with the FGIC ......................... 1389 3. Linkage of Bailouts to Corporate Governance and Systemic Risk Reform .......................................... 1391 4. A Boom-Time Role for a Crisis Agency ..................... 1393 C. The Need to Impose Limits on the FGIC ........................... 1395 D. Addressing Potential Objections to This Proposal ........... 1397 1. The Challenge of Sustaining FGIC Independence ...... 1397 2. Concern About Potential FGIC Overstretch and Federal Oversight ........................................................ 1400 3. Dangers of Creating a (De Facto) Sovereign Wealth Fund ................................................................ 1401 4. Ex Ante Versus Ex Post Approach to Conditioning Bailouts ........................................................................ 1403 CONCLUSION ...................................................................................... 1405 INTRODUCTION Since the financial crisis has subsided, politicians have responded to backlashes at Wall Street profits by renouncing bailouts en masse. Republicans who voted for bailouts now decry this government aid as misguided,1 while Democrats have optimistically proclaimed that the Dodd-Frank Wall Street Reform and Consumer Protection Act was so comprehensive that it will make corporate bailouts a relic of the past.2 The 1. See, e.g., Carl Hulse & David M. Herszenhorn, Bank Bailout Is a Potent Issue for Fall Elections, N.Y. TIMES, July 10, 2010, http://www.nytimes.com/2010/07/11/us/politics/11tarp.html (observing how Republican incumbents who voted for the Troubled Asset Relief Program (TARP) now treat bailouts as “toxic” because of the popular backlash). 2. See, e.g., Sewell Chan, Finance Bill Consensus on a Point: No Bailouts, N.Y. TIMES, Apr. 16, 2010, http://www.nytimes.com/2010/04/16/business/16fail.html (discussing the Obama http://scholarship.law.ufl.edu/flr/vol63/iss6/2 2 Manns: Building Better Bailouts: The Case for a Long-Term Investment App 2011] BUILDING BETTER BAILOUTS 1351 reality is quite different, as the prospect of bailouts will continue to shape financial markets and risk-taking.3 The question is not whether bailouts will happen, but rather how, when, and to what degree government intervention will be necessary to support financial firms during a crisis.4 The challenge is how to create a lasting framework to ensure that bailouts serve their avowed purpose of mitigating systemic (...truncated)