Lehman: The next bailout?

The rescue of Fannie and Freddie may have opened a new era of federal intervention in business.

Has the US entered a new era of government bailouts for business?

First, Uncle Sam intervened to rescue investment bank Bear Stearns. Then last week the government took over failing mortgage giants Fannie Mae and Freddie Mac.

Now Lehman Brothers is tottering – raising the prospect of another US salvage operation. And the Big Three automakers are in Washington this week with hats in hand, asking for loans to finance development of more fuel-efficient vehicles.

To some economists, actions taken so far have redefined the criteria for the type of firm the government considers "too big to fail." That's particularly true, they say, because the bailouts have occurred under a supposedly pro-free-market Republican administration.

But others say the bailouts are isolated actions. After all, Washington's 1979 provision of loan guarantees to Chrysler wasn't followed by a spike of US intervention in the marketplace.

"This is not the age of bailouts," says Peter Morici, a professor of business at the University of Maryland and former chief economist at the US International Trade Commission. "We get into these situations and then we sober up."

Size not the only factor

In the case of Bear Stearns, Fannie Mae, and Freddie Mac, company size was just one factor in the government's calculations about whether to throw them a taxpayer-funded lifeline. The nature of their connections with the rest of the economy was far more important.

If Bear Stearns went under, it could have dragged down a web of firms with which it did financial business. Fannie and Freddie together own or guarantee half the nation's mortgages. Their failure could have caused the flow of mortgage money in the US to freeze up.

But if these firms qualify for help, so might Lehman, as well as other financial institutions battered by the housing crisis, such as Washington Mutual, the nation's largest savings and loan.

Lehman is currently bigger than Bear Stearns was before its government-arranged takeover by JP Morgan Chase, after all. Lehman chief Richard Fuld has announced plans to spin off the bank's prized investment management division and split the remainder into two banking entities, one with good loans and one saddled with bad housing-backed assets. If he has time to accomplish this paring, he might reduce the institution's size enough so that US officials might decide it's OK to let it fail, if the situation comes to that.

Lehman does have one advantage that Bear Stearns lacked – access to overnight loans from the Federal Reserve. The Fed initiated this program after the Bear Stearns debacle, so that hard-pressed institutions might be able to stay afloat while they look for cash from other sources.

But Lehman got itself into trouble by making bad bets in the market, say critics of government intervention. And Washington shouldn't be helping it out.

"I don't buy the 'too big to fail' argument," says Chris Edwards, director of tax policy at the Cato Institute. "Failure is a normal happening in the marketplace. About 10 percent of all US businesses fail every year."

Detroit comes knocking

Meanwhile, the situation of the auto firms is somewhat different from that of financial institutions battered by bad housing loans.

Their argument is that they need millions of dollars to develop products that meet new fuel-economy standards imposed by Congress, and that normal debt markets aren't operating normally as the credit crisis continues to rage.

Up to $25 billion in government-supported loans for automakers were a part of the 2007 energy bill, which passed Congress and was signed into law by President Bush. But auto firms want to raise government help to $50 billion. Top Detroit officials will push for the increase in funding on Sept. 12 at an energy summit in Washington, D.C.

They have the support of many congressional Democrats. "It's very important to our country," said House Speaker Nancy Pelosi.

But backing from the Bush administration is far from assured, despite its recent moves to rescue financial institutions.

US officials know that their interventions in the market could well have negative consequences. One is pressure for help from more firms and other industries. If the airlines industry got aid following Sept. 11, why not the automakers now? And if Detroit gets help, what about other struggling old-line industries?

Lines will have to be drawn, according to officials. Otherwise, firms might actually start to engage in riskier behavior, knowing that Washington will come to the rescue.

"Mitigating that problem is one of the design challenges that we face as we consider the future evolution of our [financial aid ] system," said Fed Chairman Benjamin Bernanke in an Aug. 22 speech.

To some critics, such mitigation might be too little, too late. The financial bailouts have already expanded the notion of what firms might qualify for US help – not so much because of the firms themselves, but because it was a Republican administration that bailed them out.

"The supposedly more free-market party here has intervened to an enormous extent," says Chris Edwards of the Cato Institute.

But the overall extent of administration intervention might seem smaller if one counts Fannie Mae and Freddie Mac as only partly private-sector firms. Investors have long considered that any US administration would rescue the pair if they got into trouble – and it turns out those investors were right.

"They've been quasi-government entities all along," says Mr. Morici of the University of Maryland.