Financial History 25th Anniversary Special Edition (104, Fall 2012) | Page 44

BOOK REVIEW  BY MICHAEL A. MARTORELLI Financing Failure: A Century of Bailouts By Vern McKinley The Independent Institute, 2011 381 pages, $17.00 History shows the federal government has arranged bailouts for plenty of financial institutions from 1933 to 2009. Reasonable people can disagree over the need for those actions, and for the counterfactual history that would have occurred had the Reconstruction Finance Corporation not taken control of many banks in 1933, or had Congress not approved the Troubled Asset Relief Program (TARP) in 2008. In his provocativelytitled Financing Failure: A Century of Bailouts, Vern McKinley argues such interventions have been ill-conceived and undesirable. Moreover, he suggests government policies have been at least partially responsible for the very existence of the problems encountered by the financial institutions that sought and received federal help. Anyone trying to understand the nature of this problem will benefit from reading McKinley’s critical examination of the analyses policy makers considered (or didn’t consider) as they struggled to deal with succeeding financial crises over the past several decades. The core of Financing Failure is McKinley’s blow-by-blow descriptions of important banking crises that occurred from 1918 to 2008, and the government’s decisions to provide bailouts to various financial institutions. Since these crises usually occurred after long gaps of time, it is not surprising to read how regulators failed to learn from the actions of their predecessors. McKinley suggests in each of the most 42    FINANCIAL HISTORY  |  Fall 2012  | far-reaching crises, a government policy gone wrong had the unintended consequences of helping spawn a period of distress that not only threatened the existence of some large financial industry players, but also imperiled the entire economic system. In each case, regulators and lawmakers took aggressive actions to stem the crisis. They also went to great lengths to justify their assistance of the troubled firms, and then moved swiftly to change the prevailing rules so that such an emergency would not occur again. Any reader disappointed at the brevity of McKinley’s versions of his selected crises will welcome his extensive use of footnotes, which spotlight a plethora of sources describing additional details about those problems. McKinley traces the government’s proclivity to bailing out troubled financial institutions to the creation of the War Finance Corporation (WFC) in 1918. That agency enabled banks to continue providing credit to manufacturers contributing to the prosecution of World War I. In 1931 and 1933, Presidents Hoover and Roosevelt oversaw the creation and expansion of a similarly-structured Reconstruction Finance Corporation (RFC), which injected capital into banks suffering the effects of the Depression. The author follows the government’s subsequent ad hoc efforts to provide financial support to failing banks in selective periods of economic distress during the 1970s and 1980s. He notes the emergence of strong but unsubstantiated arguments warning that extensive interbank exposure would cause the failure of one institution to trigger a calamitous cascade of failures among many more counterparties. Indeed, in supporting the bailout of the large depositors, unsecured creditors and correspondents of flawed and failing institutions such as Franklin National (1974), First Pennsylvania (1980) and Continental Illinois (1984), regulators signaled openly