F&F Mess: Cost of Bailout

from www.nytimes.com

July 23, 2008
Cost of Loan Bailout, if Needed, Could Be $25 Billion
By DAVID M. HERSZENHORN

WASHINGTON — The proposed government rescue of the nation’s two mortgage finance giants will appear on the federal budget as a $25 billion cost to taxpayers, the independent Congressional Budget Office said on Tuesday even though officials conceded that there was no way of really knowing what, if anything, a bailout would cost.

The budget office said there was a better than even chance that the rescue package would not be needed before the end of 2009 and would not cost taxpayers any money. But the office also estimated a 5 percent chance that the mortgage companies, Fannie Mae and Freddie Mac, could lose $100 billion, which would cost taxpayers far more than $25 billion.

The House is expected to act this week on housing legislation that includes the proposed rescue plan. Legislative language has not been finalized, but the Congressional Budget Office said its estimates were based on the plan by the Treasury Department and that it did not expect significant changes in the final bill.

According to the estimate, which was delivered in the form of a letter to the House Budget Committee chairman, Representative John M. Spratt Jr., Democrat of South Carolina, the director of the budget office, Peter R. Orszag, predicted that “a significant chance, probably better than 50 percent, that the proposed new Treasury authority would not be used before it expired at the end of December 2009.”

Mr. Orszag, at a briefing with reporters, acknowledged that pinpointing the eventual cost of the package was impossible. “There is very significant uncertainty involved here,” he said.
The uncertainty runs in both directions, with some government officials and market analysts suggesting that Fannie Mae and Freddie Mac are fundamentally sound and will perform well over the long-term. Others, including some private equity managers, are pessimistic and predict heavy losses.

The rescue plan, put forward last week by the Treasury secretary, Henry M. Paulson Jr., would allow the Treasury Department to spend hundreds of billions of dollars to shore up the mortgage companies should they be at risk of collapse, either by extending credit or by purchasing equity in the companies, which are publicly traded.

Mr. Orszag said that the analysis by his office did not distinguish between the different forms of aid that might be offered — a credit line or a stock purchase — and that the analysis showed no short-term potential financial benefit for taxpayers even if Fannie Mae and Freddie Mac perform well.

But he said the analysis found substantial risk for taxpayers if the companies had steep losses and would not say if his office had analyzed the implications of a full government takeover of the companies.

How much the government will end up spending on a rescue, if one is needed, would depend on many factors, he said, including sentiment on Wall Street. “A key question becomes how does the market view the entities?” he said.

Fannie Mae and Freddie Mac are commonly referred to as government-sponsored entities, because of the long implicit guarantee that the federal government would step in to save them if they were ever in danger of collapse.

One thing that is certain as a result of the rescue proposal is that the guarantee of government aid is now much more explicit, and Mr. Orszag said that the government’s assurance that it would not let the companies fail would have to be included in any analysis of their long-term financial prospects.

Most immediately, the $25 billion cost estimate provides a precise amount that Congress will have to offset with spending cuts or tax increases if lawmakers intend to comply with “pay as you go” budget rules in the House. Lawmakers could also decide that the $25 billion should be viewed as emergency spending and simply added to the national debt.
There was little immediate reaction to the projections on Capitol Hill as lawmakers and staff members reviewed the complicated calculations and the various assumptions they were based on.

Mr. Spratt, the chairman of the Budget Committee, issued a statement praising the Congressional Budget Office for moving quickly to produce its analysis. “Estimating the fiscal impact of this proposal is complex and involves considerable uncertainty,” Mr. Spratt said. “And not everyone will necessarily agree with every aspect of C.B.O.’s analysis.”
But he added: “C.B.O. is performing its important institutional role by providing in a timely manner its best professional and independent assessment.”

The analysis by the Congressional Budget Office also offered a sobering assessment of the mortgage giants based on several different metrics.

Under generally accepted accounting principles, Mr. Orszag said that the net worth of the mortgage giants at the end of the first quarter of 2008 was about $55 billion. He also said that the companies held more than $80 billion in capital at the end of March and for regulatory purposes were considered to be "adequately capitalized" by the Department of Housing and Urban Development.

But on a fair value basis, the value of the mortgage companies’ assets exceeded their liabilities at the end of March by just $7 billion, a thin cushion considering liabilities at the time of $1.6 trillion, and an indication of why there have been numerous calls for the companies to raise additional capital. Mr. Orszag also noted that on July 11, before the Bush administration proposed its rescue plan, the total value of shares in Fannie Mae and Freddie Mac had fallen to a low of $11 billion. Shares in the companies are now worth about $20 billion.

The House is expected to vote on the larger package of housing legislation, including the rescue plan for the mortgage companies, as early as Wednesday, and the Senate is expected to quickly follow and send the bill to President Bush.

Among the issues that lawmakers have been debating is whether to exempt from the federal debt limit any expenditure that the Treasury Department makes on behalf of the mortgage companies. The current debt limit is $9.815 trillion and outstanding federal debt is roughly $9.5 trillion, leaving a cushion of $310 billion.

Congressional Democrats have expressed opposition to exempting the rescue plan from the debt limit, saying administration officials should come back to Congress for emergency authorization if additional spending is needed. Officials said it was probable that a compromise would be reached and the debt limit would still apply.

The housing legislation also includes the creation of a regulator for the mortgage companies, an agency apart from the Department of Housing and Urban Development, which oversees the mortgage giants.

Some critics have questioned whether the new regulator would have sufficient authority to swiftly increase capital requirements — the amount of cash that the mortgage companies need to maintain to protect against losses.

In his letter to Mr. Spratt, Mr. Orszag suggested that simply enacting the proposed rescue plan could bolster the confidence of Wall Street in Fannie Mae and Freddie Mac.

“Private markets might be sufficiently reassured to provide the GSE’s with adequate capital to continue operations without any infusion of funds from the Treasury,” he wrote. “during that time, it is possible that expectations about the duration and depth of the housing market downturn may brighten.”

But Mr. Orszag said his office had also consulted with market investors with a different outlook. “Many analysis and traders believe there is a significant likelihood that conditions in the housing and financial markets could deteriorate more than already reflected on the GSEs’ balance sheets,” he wrote, “and such continuing problems would increase the probability that this new authority would have to be used.”

Taking into account all of the different possibilities and sentiments, and measuring them against the budget “scorekeeping” rules, Mr. Orszag said his office had concluded “that the expected value of the federal budgetary cost from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.”

25 bil huh? Try 10x that number....