from calculatedrisk.blogspot.com
Friday, September 19, 2008
The Price of the Bailout
by CalculatedRisk
Secretary Paulson said: "We're talking hundreds of billions."The NY Times DealBook has other estimates: Putting a Price Tag on a Government Bailout
“It’s probably $500 [billion] to a trillion dollars, and that’s going to visit the taxpayers sooner or later,” [Sen. Richard Shelby] said. “It’s either going to be a debt charged to all of us or to all our children.”...Bloomberg News ... reported that the government is considering establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corporation to insure investors in money-market funds.
However buying the assets isn't enough. These asset sales will lead to substantial write-downs, and that will reduce the regulatory capital at the banks. So how do the banks recapitalize?The hope is that by making the assets transparent, and selling off the toxic waste, that will rebuild confidence with investors. Maybe.
But the U.S. Government might also have to help recapitalize the banks to keep them lending (like the Reconstruction Finance Corporation (RFC) did during the Depression). Either way, it appears the current shareholders face massive dilution.
Also - as an aside - when the banks make their assets transparent (should be a requirement for participation), we will discover if any executives misrepresented their assets and filed false reports with the SEC. That could be prosecuted under Sarbanes-Oxley, and perhaps a few executives spending time in jail might help with the moral hazard issues.
I am not sure I would want to be a long term shareholder of some Financial firms with large Tier 3 assets.
Showing posts with label Bailout. Show all posts
Showing posts with label Bailout. Show all posts
Friday, September 19, 2008
Ballpark: 1-2 Trillion and counting....
from ft.com (Financial Times)
America will need a $1,000bn bail-out
ByKenneth Rogoff
Published: September 17 2008 19:06 Last updated: September 17 2008 19:06
One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.
But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.
It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, Wednesday’s $85bn bail-out of the insurance giant AIG.
Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.
True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible.
It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.
Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.
It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.
Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.
A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.
The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.
It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.
Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.
The writer is professor of economics at Harvard University and former chief economist of the International Monetary Fund
Several important points are raised. First - we are going to reflate (read inflate) - read the Fed statement from a couple of days ago again. They're concerned (wink, wink) about inflation. What they're actually saying is: we'll do anything to avoid zero bound on interest rates. Anything to avoid Japan 2.0 and deflation. Second - the cost is 1 - 2 Trillion dollars. I think 1 Trillion is the LOWER bound. The ultimate costs of Nationalization, Backstopping, creating a TARP / Bad Bank whatever you call this will include costs of: Fannie and Freddie, Nationalization Insolvent Banks, AIG and the cost of TARP that Hank Paulson discussed today. It means that inflation is certain as money (debt) is created. Dollar will likely fall and Gold and Commodities will rise. Again.
America will need a $1,000bn bail-out
ByKenneth Rogoff
Published: September 17 2008 19:06 Last updated: September 17 2008 19:06
One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.
But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.
It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, Wednesday’s $85bn bail-out of the insurance giant AIG.
Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.
True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible.
It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.
Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.
It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.
Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.
A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.
The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.
It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.
Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.
The writer is professor of economics at Harvard University and former chief economist of the International Monetary Fund
Several important points are raised. First - we are going to reflate (read inflate) - read the Fed statement from a couple of days ago again. They're concerned (wink, wink) about inflation. What they're actually saying is: we'll do anything to avoid zero bound on interest rates. Anything to avoid Japan 2.0 and deflation. Second - the cost is 1 - 2 Trillion dollars. I think 1 Trillion is the LOWER bound. The ultimate costs of Nationalization, Backstopping, creating a TARP / Bad Bank whatever you call this will include costs of: Fannie and Freddie, Nationalization Insolvent Banks, AIG and the cost of TARP that Hank Paulson discussed today. It means that inflation is certain as money (debt) is created. Dollar will likely fall and Gold and Commodities will rise. Again.
Tuesday, July 22, 2008
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....
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....
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