Indiana Law Journal Volume 67 Issue 4 Article 5 Fall 1992 Overt and Covert Bailouts: Developing a Public Bailout Policy Cheryl D. Block George Washington University National Law Center Follow this and additional works at: https://www.repository.law.indiana.edu/ilj Part of the Banking and Finance Law Commons Recommended Citation Block, Cheryl D. (1992) "Overt and Covert Bailouts: Developing a Public Bailout Policy," Indiana Law Journal: Vol. 67 : Iss. 4 , Article 5. Available at: https://www.repository.law.indiana.edu/ilj/vol67/iss4/5 This Article is brought to you for free and open access by the Law School Journals at Digital Repository @ Maurer Law. It has been accepted for inclusion in Indiana Law Journal by an authorized editor of Digital Repository @ Maurer Law. For more information, please contact [email protected]. Overt and Covert Bailouts: Developing a Public Bailout Policy CHERYL D. BLOCK* Table of Contents INTRODUCTION ....................................................................... 952 I. DEFINITIONS AND CLASSIFICATION MODELS ........................ 955 A. What Is a Bailout?............................................... 955 1. Bailout as a Form of Government Subsidy .......... 956 2. A Proposed Definition ..................................... 959 3. Clarifying Misconceptions: Bailout Costs ............ 962 4. The Public v. Private Bailout Distinction ............ 965 B. A Taxonomy of Bailouts ....................................... 968 1. Overt v. Covert Bailouts .................................. 968 2. Prospective v. Retrospective Bailouts .................. 972 3. Generic v. Specific Bailouts .............................. 976 4. Regulatory Bailouts ......................................... 977 5. The Mixed-Motive Bailout ................................ 980 II. THE PUBLIC POLICY DEBATE: To BAIL OUT OR NOT To BAIL OUT? ................... 981 A. Alternative Methods for Allocating Risk of Loss ....... 981 1. No Shifting of Loss ........................................ 981 2. Allocation of Loss Through the Tort Regime ...... 982 3. The Insurance Alternative ................................. 984 4. The Bankruptcy Alternative .............................. 987 B. The Free Market Presumption Against Bailout .......... 990 C. Overcoming the Presumption Against Bailout............ 993 1. The Public Interest v. Pluralist Approaches ......... 993 2. The Distributive Justice Approach ..................... 999 III. DEVELOPING A SUBSTANTIVE AND PROCEDURAL BAILOUT POLICY ...................................................................... 1008 * Associate Professor of Law, George Washington University National Law Center. The author gratefully acknowledges helpful comments on earlier drafts by Professors John Flynn, Miriam Galston, Donald Gjerdingen, Harold Green, Chad McDaniel, Lawrence Mitchell, Thomas Morgan, Beth Nolan, Joe Oppenheimer, Julie Roin, Stephen Saltzburg, Joshua Schwartz, Johnathan Turley, and Luize Zubrow, as well as reactions from colleagues following a works-in-progress presentation. In addition, the author gratefully acknowledges the valuable research assistance of Pamela Burke, Gerald Ferrano, Varsha Pradhan, and Renee Safier. Summer research funds from the George Washington University National Law Center provided support for this research. INDIANA LAW JOURNAL [Vol. 67:951 A. Enacting "Public-Regarding" Bailout Legislation....... 1008 B. Developing a Substantive Standard.......................... 1010 1. Preconditions to Bailout ................................... 1010 2. Substantive Policy Assessment ........................... 1013 C. Developing ProceduralStandards ............................ 1021 1. Need for a Central Monitoring Agency ............... 1021 2. Structure and Location of a Monitoring Agency .. 1025 3. Congressional Committee Structure .................... 1027 4. Deliberative Reforms ....................................... 1027 IV. STRUCTURING AND FUNDNG THE BAILOUT ....................... 1030 A. Structuring the Bailout .......................................... 1031 1. Government Involvement in Management ............ 1031 2. Structuring the Loan or Loan Guaranty ............. 1032 3. Federal Insurance Programs .............................. 1033 B. Funding and Distributing Bailout Cost ..................... 1034 CONCLUSION .......................................................................... 1036 INTRODUCTION "Bailout" has become an increasingly familiar term in our popular vocabulary. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),' the legislation providing for the bailout of the nation's savings and loan institutions, is one of the more dramatic, contro- versial, and expensive pieces of federal legislation in our history. 2 Although the term bailout is reasonably new, the "bailout phenomenon" is not. History provides numerous examples, including legislation to assist the Chrysler Corporation,3 Lockheed Aircraft Corporation, 4 New York City,5 1. Pub. L. No. 101-73, 103 Stat. 183. 2. A precise estimate on the overall cost of the savings and loan bailout is difficult to find. Differing estimates have been done by the Resolution Trust Corporation (RTC), created under FIRREA, the Congressional Budget Office (CBO), and the General Accounting Office (GAO). Figures are updated to reflect changing economic conditions, changing real estate markets, and the number of institutions likely to require assistance. One recent GAO estimate figured cost through 1999 at $335-370 billion. Resolving Failed Savings and Loan Institutions: Estimated Costs and Additional Funding Needs: Hearings Before the House Comm. on Ways and Means, 101st Cong., 2d Sess. 1 (1990) [hereinafter Hearings] (statement of Charles Bowsher, U.S. Comptroller General). 3. Chrysler Corporation Loan Guarantee Act of 1979, Pub. L. No. 96-185, 93 Stat. 1324 (1980). 4. Emergency Loan Guarantee Act, Pub. L. No. 92-70, 85 Stat. 178 (1971). Although this Act was general in scope, its passage was motivated by the financial problems of the Lockheed Aircraft Corporation. H.R. REP. No. 379, 92d Cong., Ist Sess. 1272 (1971). 5. New York City Loan Guarantee Act of 1978, Pub. L. No. 95-339, 92 Stat. 460; New York City Seasonal Financing Act of 1975, Pub. L. No. 94-143, 89 Stat. 797. 19921 PUBLIC BAILOUTS and certain railroads.6 In each case, the government intervened to assist an industry, individual firm, or municipality in financial distress. Yet other recent instances of industry or firm failure have not received a particularly sympathetic hearing from the government. In response to re- quests for assistance from the airline industry, for example, the Federal Aviation Administration responded that "direct financial aid is not called for and would probably do more harm than good to the competitive process. ' 7 Similarly, requests for government assistance to prevent the imminent bankruptcy of the Drexel Burnham Lambert Group, a major securities firm, fell on deaf ears. Going even further than the FAA, Alan Greenspan, Chairman of the Federal Reserve Board, indicated that federal authorities probably would refuse to rescue even the largest securities firms threatened with such failure.' Industries, individual firms, or municipalities will again appear before Congress to request assistance in times of crisis. Indeed, an emerging crisis already may exist in the insurance industry. A recent report cautioned that "the same early warnings of potential disaster are abundantly evident, as they were 5 years ago in the thrift industry. If such warnings are not heeded, the insurance industry and the nation could face a solvency crisis rivaling the present savings and loan situation." 9 Similar concerns have been raised regarding the nation's pension funds. 10 Assuming that some government 6. United States Railway Association Amendments Act of 1978, Pub. L. No. 95-565, 92 Stat. 2397; Regional Rail Reorganization Act of 1973, Pub. L. No. 93-236, 87 Stat. 985 (1974). 7. Hearings Before the House Public Works Comm., 102d Cong., IstSess. (March 5, 1991) (testimony by James Busey, Federal Aviation Administration). 8. When asked if the government would have intervened to assist a larger investment house such as Merrill Lynch or Smith Barney instead of Drexel, Greenspan replied that, regardless of the institution involved, the government actions would have been the same if the financial conditions were all the same. Leveraged Buyouts and Bankruptcy: Hearings Before the House Subcomm. on Econ. and Commercial Law of the Comm. on the Judiciary, 101st Cong., 2d Sess. 106 (1990) (testimony of Alan Greenspan, Chairman, Board of Governors, Federal Reserve System). In discussing the controversial "too-big-to-fall" issue as applied to banks, Chairman Greenspan responded that "setting up a system in which commercial banks can be too big to fall is not good policy, needless to say. It is not good for the system, it's not good for the discipline of the system, and ... it's certainly not equitable." Id. at 107. 9. REPORT BY THE SUBCOMM. ON OVERSIGHT AND INVESTIGATIONS OF THE COMM. ON ENERGY 2 AND COMMERCE, 101ST CONG., D Sass., FArtED PROmnsEs: INsURANCE COMANY INSOLVENCIES 2 (Comm. Print 1990). Since this report, several large insurance companies have experienced difficulties necessitating government intervention. See, e.g., New Jersey Is Preparing to Seize Mutual Benefit, A Large Insurer, N.Y. Times, July 13, 1991, at Al, col. 1. The National Organization of Life and Health Insurance Guaranty Associations recently