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Who Really Benefits From Bailouts?

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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I always find it amusing whenever someone expresses surprise that the financial bailouts for Greece haven't benefited Greek citizens. "Bailout Money Goes to Greece, Only to Flow Out Again" in the New York Times is just the latest example. "The cash exodus is a small piece of a bigger puzzle over why — despite two major international bailouts — the Greek economy is in worse shape and more deeply in debt."

Unfortunately, this is a feature of bailout, not a bug.

A plethora of financial rescues during the past decades has proven quite convincingly that this isn't an aberration. Follow the money instead of following the headlines. That's how you learn who profits from a bailout.

Look around the world -- Japan, Sweden, Brazil, Mexico, Ireland, the U.S. and now Greece to learn who is and isn't helped by these enormous government-backed bailouts. No, it isn't the Greek people, nor even their banks. They never were the intended beneficiaries of the bailouts, nor were Irish citizens in that bailout. Indeed, homeowners in the U.S. were little more that incidental recipients of aid as a percentage of total rescue spending. 

You probably learned the phrase "moral hazard" during the financial crisis. In short, what it means is that the bailouts rescued leveraged, reckless speculators from the results of their unwise professional folly and gave them an incentive to do it all over again. They were and are the intended rescuees.

Do you think I am exaggerating? Consider the U.S. bailout in its manifold forms, from TARP to ZIRP to QE. How many bondholders suffered losses from their poor investment decisions? With the exception of holders of Lehman Brothers' debt and a handful of banks that weren't deemed too big to fail, just about every other bondholder was made whole, 100 cents on the dollar.

Thanks to rescue plans such as the Trouble Asset Relief Program, holders of bonds from a diverse assortment of failed and failing companies suffered literally no losses. American International Group? Zero losses. Government sponsored entities Fannie Mae and Freddie Mac? Zero losses. Banking giants Citigroup and Bank of America? Zero losses. Morgan Stanley, Merrill Lynch, Goldman Sachs, Bear Stearns? Zero losses.

The Federal Deposit Insurance Corp.'s actions were rare exceptions to this rule: Its bailouts actually benefitted consumers -- savings and checking account holders. When banks such as Indy Mac, Wachovia, Washington Mutual went belly up, the FDIC arranged a shotgun marriages. WaMu went to JPMorgan Chase, Wachovia went to Wells Fargo, Indy Mac went to OneWest Bank.

Once it was certain the account holders were made whole, whatever assets were left went to the most senior creditors -- typically bond holders. (Equity holders usually get wiped out). In Washington Mutual's case, bond owners received between 20 and 28 cents on the dollar. Other FDIC resolutions yielded similar amounts.

Even the Federal Reserve's zero interest rate policy (ZIRP), in place for so long that there hasn't been a rate increase in more than nine years, is there to help rescued banks. For years after the financial crisis, their balance sheets remain festooned with so many bad mortgages and soured loans that an early increase in rates would have put those portfolios at huge risk. Now that prices have mostly returned to pre-crisis levels, it is considered safe to increase the fed funds rates, which we all know will have a significant impact on mortgage rates. With foreclosures down tremendously from their peak, the banks can tolerate interest increases. Despite plenty of evidence that the economy could have absorbed interest rates increases almost two year ago -- the economy met the Fed’s own parameters at that time -- bank mortgage portfolios were still shaky, and not in shape to deal with rate increases. More losses that could have compromised the banking industry's health were likely.

So if you think that it is just a coincidence that rates are likely to rise only now, when bank balance sheets can tolerate them, you haven't been paying close attention.

History teaches us that when companies fail, they file either a reorganization or liquidation in a bankruptcy court. The exceptions are when well-placed executives are friendly with Congress (Chrysler 1980) or members of the Joint Chiefs of Staff (Lockheed 1972) or Treasury secretaries (all of Wall Street except Dick Fuld in 2008-09). Having well-connected corporate executives on your board or in senior management sure comes in handy during an emergency.

Which brings us back to Greece.

Its leaders never learned the lesson that Ireland eventually figured out and tiny Iceland understood from the start. The phrase systemic risk is nothing more than code; what it actually means is that a politically connected banker wants the government to cover losses on bad investments.

In the case of Greece, the money flows in large part from European governments and the International Monetary Fund through Greece, and then to various private-sector lenders. We all call it a Greek bailout, because if it were called the "Rescue of German bankers from the results of their Athenian lending folly," who would support it?

Our moral compass informs us that bailouts shouldn't work to the benefit of the reckless and irresponsible. Reality teaches us a very different lesson.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net