In 2008, the government took historic measures to stabilize the financial industry by providing the Treasury unprecedented power to bail out the banks. Almost immediately after, the controversial move was despised by free-marketers everywhere. However, more pragmatic economic observers noted that they were unsavory, but unavoidable. 18 months later -- surprise! -- they actually appear to have worked pretty well. Andrew Ross Sorkin notes this revelation in his New York Times column today. Considering the underlying causes of the financial crisis, this should not be a shock.
Stabilizing the Market
The first important objective of the bailout was to stabilize the financial markets. That happened relatively quickly. It should have: when the U.S. government makes a choice to essentially prevent an industry from failing that goes a long way in calming markets. As soon as investors realized that the risk they feared would be covered by Uncle Sam, there was far less fear about banking. The credit crunch then began to lessen.
Several months later, the government decided to conduct a series of stress tests on the largest banks. That confirmed to the market that the Treasury would stand behind these firms. Again, investors were relieved and less worried about risk. The stress tests, thus, made it even less likely the bailouts would fail.