Expect More Bailouts in 2010

by: Daryl Montgomery

There is no end in sight for U.S. bailouts stemming from the Credit Crisis. Once you've bailed out wealthy Wall Street bankers (and there are a handful of Federal Reserve programs for accomplishing this in addition to the $700 billion TARP program and some tax giveaways), it isn't politically tenable to say no to pensioners, savers, homeowners and local governments. It should be kept in mind that the Credit Crisis didn't create the problems, but merely exposed the rot in the system that had been there for many years. As Warren Buffett most famously said, "you only know who's swimming naked when the tide goes out". Well, a lot of U.S. government operations have been swimming naked for years and the Credit Crisis caused the tide to go out.

The U.S. government already nationalized massive housing loan entities Fannie Mae and Freddie Mac in September 2008 and these have become bottomless pits for government aid since then. Fannie lost $18.9 billion in the third quarter of 2009 and requested an additional $15 billion in funding. On Christmas Eve, when Americans were busy celebrating the holiday and not paying attention to the news, the federal government announced that it had raised the bailout cap for Fannie and Freddie to $400 billion. By making the change before the end of the year, the Treasury department didn’t have to get congressional approval. The government’s financial support will increase based on how much each firm loses in the previous quarter. So the more they fail, the more they get in 2010 - some incentive for making things better.

Fannie and Freddie would be in even worse fiscal shape, if much of the loans that had previously been handled by them weren't currently being insured by the FHA (Federal Housing Administration). The FHA is now backing loans that would have made a crooked subprime mortgage broker blush in the heyday of the housing bubble. When it comes to getting FHA insurance these days, bad credit, a spotty work history, and even a previous foreclosure aren't deal breakers. Not surprisingly, FHA finances are spiraling downhill fast and warnings about a need for a bailout are already becoming louder. If somehow the FHA manages to get through 2010 without a bailout, it will wind up being bailed out in the first half of 2011 instead.

The FDIC has temporarily solved its need for a bailout, with temporarily being the operative word. On November 12th the FDIC mandated that banks pay three years of their insurance premiums up front. This will provide the FDIC's insolvent bank deposit insurance program with an immediate cash infusion of $45 billion. Unfortunately, the FDIC itself estimates that its funding needs will be $100 billion in the next four years. Assuming they only need that amount, and this is quite possibly an overly optimistic estimate, they will still have a serious shortfall.

There have been 140 bank failures in the U.S. as of the third week in December. The most recent week of failures cost the FDIC $1.8 billion. If that was the case every week, the FDIC ‘s deposit insurance fund would be out of money again in only 25 weeks or less than half a year. At the end of the third quarter, there were 512 troubled banks on the FDIC list. This was up substantially from the second quarter, which in turn was up substantially from the first quarter. The chances of the FDIC getting through 2010 without a cash infusion from the federal government seem to be slim indeed.

The PBGC (Pension Benefit Guaranty Corporation), a government chartered company that insures U.S. pensions, is another operation that is heading toward a bailout. In its 35 years of operation, the PBGC has lost money in 29. Losses have even taken place when the U.S. economy was strong and the stock market rallied. In bad years, the PBGC loses even more money. In 2009, it has taken over 144 pension programs that have failed compared to 67 in 2008. It was $22 billion in the red this year. According to an inspector general's report, the PBGC's former director was alleged to have had improper contacts with Wall Street. When questioned by a congressional panel, he took the Fifth Amendment (refusing to answer because it might tend to incriminate him). Fannie Mae and Freddie Mac executives were also cited for serious ethical lapses before their operations had to be taken over by the government. Corruption and bailouts seem to go hand in hand.

While California's budget woes are well known, there are nine other U.S. states that are in serious financial trouble and as many as 47 that are not financially sound. California has a $121 billion budget gap and is resorting to IOUs to make payments. According to the Pew Center, the nine other states in serious trouble are Arizona, Michigan, Nevada, Florida (states hit hardest by the housing downturn along with California), Rhode Island, Oregon, New Jersey, Illinois and Wisconsin. High unemployment and reduced business activity have caused tax receipts to plummet and are the prime cause of the current fiscal distress.

There is little evidence the problem is getting better despite claims by the federal authorities and mainstream economists that the recession is over. The federal government has the same problem as the states, but it can print money to make ends meet. While the feds can bail out the states, who's going to bail out the U.S. when money printing doesn't work anymore?