Transforming Bailouts Into Investments

Jeffrey D. Manns, George Washington University

Abstract

This Article seeks to fill a crucial gap in the Dodd-Frank Financial Reform Act, which failed to create a framework for dealing with future financial bailouts. This Article argues that the federal government’s “break even” approach to the recent bailouts not only shortchanged taxpayers, but more importantly failed to provide deterrence against the type of reckless risk taking that led to the financial crisis. This Article argues that the key to legitimizing future bailouts and limiting moral hazard is to institutionalize a long-term investment-oriented approach that delineates clear contours and conditions for aid. An investment approach would provide financing to companies during financial crises that the private sector cannot provide, yet also impose long-term strings attached of investment terms and conditions to provide disincentives for over-reliance on bailouts and leveraged speculation. This Article calls for establishing an independent agency, the Federal Government Investment Corporation (“FGIC”), to serve as an investor of last resort, which would make bailout monies contingent on beneficiaries sharing risks and long-term returns with taxpayers. The FGIC would establish express, ex ante conditions for providing aid that would temper corporate risk taking, protect taxpayers, and establish bounds to bailouts. Tying government bailouts to shared sacrifices with managers, shareholders, and creditors of beneficiaries, proportional profit sharing with taxpayers, and corporate governance reforms would help to ensure that bailouts serve a productive purpose.