Too Big to Fail: Bailouts explained
David Marin
June 29, 2021
  |  

Too Big to Fail: Bailouts explained

David Marin
June 29, 2021
  |  

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Broadly speaking, a bailout is to provide financial assistance to an entity about to fail. And yes, in recent history the US government has stepped in a few big times to save the day. 

You see? Sometimes the crisis may come from a specific industry or sector of the economy, like the housing market crash of 2008, which ended up blowing up on Wall Street. When the government has to refill the banks and financial institutions with money, to keep the system from going down. That is referred to as a corporate bailout. 

It is not a popular move by any means.

You get acquainted with economic recessions as you grow old and live through one or two. It is when economic and social events escalate to a tipping point and the economy starts to decrease. And you know who always gets the worst part of it. Hint, it’s not the big bankers or corporations. 

It seems like, when they lose, the government comes to the rescue. They’re too big to fail. 

But even when the crisis is not about the bankers' greed. Even when it’s something like a pandemic virus, the big players still manage to get the best of it. Did you know more than half of the money that the government has been injecting into the economy to fight the Covid crisis, still went to the corporate sector?

Regardless of what causes the crisis, it’s the central bank’s job to deal with economic recession times, and it has mechanisms to do it rather regularly. But the massive scale of the latest money injections has been staggering and you may have some questions around the topic, just like us.

Probably, the first one is, where does the government get all that money from? And, where does it go? Does it really help those most affected, or does it just save a high-stakes gambling game in the economy?


But first, when do things get so bad that the government needs to step in? Current times are a great example. In fact, the largest economic intervention by the government in US history is undergoing as we make this video.

Although some cities seem to be getting over the Covid crisis now, the truth is that it has been ruthless. Hospitals collapsed and businesses of all kinds were shut down for months, leading to record unemployment rates and a deep economic recession. 

So, in March this year, the US Congress, under Joe Biden’s presidency, approved the American Rescue Plan Act, or ARPA, which consisted of a massive $1.9 Trillion package to support public health and different actors of the economy, from businesses, to individuals.

And only a year before, when the pandemic was unfolding, the former president Donald Trump had approved the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. It was a historic $2.2 Trillion stimulus and bailout package.

Yeah, the US government pulled off more than $4T to reinject into the economy, in only a year. That's around 20% of America’s GDP. It’s about two times the value of Apple. It 's ridiculous. So, where do they get all that money from? 


There is no simple answer to that, but there are different mechanisms that federal authorities use in order to keep the economy afloat.

In the US, the main institutions involved are the Treasury Department, which collects taxes and manages public funds. The Federal Reserve, or the Fed, which is the country’s Central Bank. And these two are the ones that can create money. Particularly the Central Bank. And then finally, they need to get their monetary policies approved by the Congress.  

The Treasury and the Fed share three major mandates: maximizing employment, stabilizing prices and inflation, and monitoring interest rates. To do this, they control the supply of money that circulates through monetary policy. That means, they can create or restrict money in order to keep things balanced.  

And, it’s no longer printed money, so forget those old images of printers churning out bills. It's all digital, of course. Zeros and ones on computers that translate credit directly into accounts.

To do it, the Fed basically engages in lending and borrowing money in the securities markets. 

Here is where things may get complicated, so let me refresh some basics. What? You thought only the corporate guy knows about business? I got this.  

For starters, a Security is a financial asset that can be traded. Two of the main security categories are Equity, like stocks, and Debt Securities, like bonds or mortgages. These are financial assets businesses can use to raise capital. 

Just like stocks are sold and traded in public exchanges, there’s also a public Bond Market. Yeah, it may not be as cool as the stock market, but it is quite larger actually, and is where a lot of the bailout action happens.

The Bond Market is made up of issuers, that can be corporations, public entities like municipalities, or federal agencies, looking to borrow money from investors. And they do it by issuing and selling bonds.

So, let’s quickly try to understand Bonds. A bond is essentially a loan. Banks, and financial institutions can raise capital in the bond market by issuing and selling bonds. The bonds are IOU, or I Owe You certificates, which is basically a promise of paying the money back.

There are different bond nominations, ranging roughly from $100 to $5M. When an investor, that can be another bank or institution, buys a bond, it essentially loans the money to the issuer. 

For the investor, the bond is the promise of getting the money back, plus some gains over time, a.k.a the interest. And the maturity of the bond determines the time in which the issuer needs to pay the full amount back. There are short, medium, and long term bonds.

But who ultimately run the market are the Treasury Department and the Federal Reserve. Yeah, the Treasury collects taxes, but also raises capital by issuing bonds in the market. This way, they may finance public projects like infrastructure spending, but also control the money supply. How? We’re getting close to the money-creation part. 

So, the Treasury regularly borrows money from the market through bonds, but when the economy needs to be rebalanced, it’s the Central Bank that goes out to the market and buys those treasury securities back from the banks and institutions that hold them. 

An oversimplified way to put it, is that the Fed buys the Treasury’s debt. And to buy the bonds, the Fed just creates the money. Voilá. No bills are printed. They credit the money directly to the account of the bondholder, the banks and institutions. 

By buying mainly short-term treasury bonds, the Fed injects money into the banking system, with the intention that there is more money to loan to the public, at lower interest rates. 

Lwer interest rates mean that borrowing money for people and businesses is cheaper, and this helps keep the economy active. These money-creation interventions are known as Open Market Operations, and are considered conventional ways to keep the economy balanced.

And that’s broadly how the Fed puts new money into the economy. And what do they do with all those bonds that they buy? The Fed holds them in its balance sheet, as assets. 

Check out the Bankruptcy video if you haven’t, we talk about assets, liabilities, and balance sheets there. So, after the 2020 and 2021 bailout operations, the assets reported in the Fed’s balance sheet went from roughly $4.1 trillion in March 2020, to almost doubling up to $7.9 trillion as of now, which is nuts. 


But conventional Open Market Operations haven’t been enough to face the latest crises. So, the Fed goes further to implement unconventional methods, which are known as Quantitative Easing and are quite controversial. 

No need to get more technical, though. Let’s just say that QE is a more aggressive intervention by the Fed in the securities market, to buy not only treasury bonds but also other riskier assets like longer term bonds, corporate bonds, and mortgage-backed securities, as well as special loan programs for the banks. 

Riskier means that those assets are backed by debt that is likely not getting paid. And, you see, risky assets like mortgage-backed securities were at the very heart of the 2008 recession. That is a whole ‘nother story in itself, let us know down in the comments if you’d be interested in a full episode about it, we’d love to do it.

Back then, all the main Wall Street banks and financial institutions, the likes of Bear Stearns, Goldman Sachs, Lehman Brothers, Citigroup, and more, all found themselves holding tons and tons of toxic assets, in the form of mortgage-backed securities that weren’t getting paid.

Why? Because they had been pumping mortgages in the housing market, taking high risks with the loans and making equally high profits selling and reselling the mortgages in the securities markets. It was a wild chain of speculation that fed Wall Street’s guts for years.

And that’s why those bailouts were so unpopular. The public perceived it more as saving greedy bankers, than a rescue of the economy. But the reality was that the banks were all on the verge of bankruptcy, threatening to leave the country without cash and cause economic distress globally.


Even the president back then, George W. Bush, a firm believer of free markets, was reluctant to collaborate in the bailout at first, when the Treasury and the Fed came up with the TARP Act, or Troubled Asset Relief Program. It consisted of massive QE operations, in order to buy hundreds of billions of dollars of bad assets from the banks, re-injecting them with more than $700B.

Approving the 2008 bailout legislation wasn’t easy. There was opposition in both parties of the Congress, some Republican representatives, of course, called it a slippery slope to socialism. 

But, like it or not, if the government doesn’t do it, then the financial system might collapse and bring the economy down with it. That is pretty much what happened in Wall Street in 2008.

Getting to the end of this video, let’s try to see if the controversial 2008 bailouts and the Covid relief programs are any similar. In the end, both times the Government has engaged in QE operations to  inject massive amounts of money into the economy.

Broadly speaking, the Covid relief packages were more social interventions than just financial, and required larger coverage. They do contemplate funds for public health, stimulus packages for individuals and families, forgivable loans, and tax cuts for small businesses. 


Back in 2008, no money went to individuals, or public health, or small businesses of any kind. It was an injection of hundreds of billions all distributed among the main Wall Street banks, to buy toxic assets back from them and save the system. 

And it must be said that the majority of the funds that were given have already been repaid, even generating margins for the government. The TARP was a successful program of money injection that managed to keep acceptable inflation rates.

Still, the 2008 crisis had irreparable consequences on the public trust in the system. People felt like their money, the public funds of the state, was being used to save greedy bankers. It caused social unrest and heated protests against Wall Street and the government, and there was little the authorities could do to change that perception.

Back to today, the Covid relief interventions were approved in Congress with a sense of urgency, for the most part. But some did raise their voice to claim that these relief programs came with probably the largest corporate bailouts in US history too. Damn. 

Yeah, forget for a moment about the stimulus checks, because the truth is that more than half of the relief funds, that is more than $2T, went to businesses, according to the Washington Post

And yes, that includes again, hundreds of billions for large corporations, and market-stabilization operations, like purchasing corporate bonds, mortgage-backed securities, and other risky assets, in quite similar fashion to 2008.

But the truth is that even before Covid, corporate debt was already at threatening record levels, so a lifesaver for the corporate sector may have been in order. According to CNBC, corporate debt today stands beyond $10T, in what can perfectly be a time bomb.

If we have learned anything today, it is that poorly managed debt  in the corporate world can blow up the economy. So, while a good $500B went to aid big corporations, small businesses got a few hundred billion less, in lending programs that have been widely criticized for failing to reach those most in need, the smaller ones.

There have been critics that smaller businesses have been required to keep all workers on payroll in order to access the funds, while other larger businesses haven’t. And so on. 


One last thing to remember from all this, is that there’s a very delicate balance between how much money the government can create to keep the economy from a recession, but without overflowing it and causing other unwanted outcomes like inflation.

Inflation is one of the major concerns that emerge after the Central Bank performs these money-creating stunts. It’s the risk of essentially having too much money out there chasing too few goods, making money lose value and the cost of life go up.

Extreme cases of hyperinflation can be seen in countries like Zimbabwe or Venezuela, where it is easier to weigh money, or to create one hundred trillion banknotes, than to count it. And even with kilos of money, you can’t afford anything. 

And yes, consumer prices are surging in the US, more than 4.2% in April 2021, the most in any 12-month period since 2008. Have you seen any long lines to buy gas, and stores out of lumber? Well, it might be a sign of the times. 

Officials from the Fed have said they were surprised, but they hold their ground and are confident that they will keep inflation at the expected 2% rate. But many are already ringing the inflation bells, and some like Warren Buffet just confirm that prices are going up on a daily basis. 

So, what do you think? Do you see the cost of life going up after these trillionaire money injections? Are you ok with public funds used to bailout banks and corporations? Or do you think they should be held accountable and take the losses for their greedy risk management?

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