Costs to Prevent Economic Free Fall

A budget tells us what we can't afford, but it doesn't keep us from buying it. – William Feather

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke met late last week to brief and lead Congressional leaders through the economic pandemonium now occurring. One solution proposed was the creation of a new Resolution Trust Corporation similar to the one created to solve the Savings and Loan Crisis in the late 1980’s. Jane Sasseem of Business Week reported:

Whatever form it takes, however, a move to shift bad mortgage assets from the balance sheets of private institutions and onto that of Uncle Sam raises plenty of questions -- not least, how much such a bailout would cost. The original RTC took on some $225 billion in junky S&L assets and eventually sold them for $140 billion, so the hit to taxpayers was $85 billion. No one knows how much bad debt a new RTC would have to take on, or what the burden might ultimately be worth, but the price tag could be far higher. Restructuring the complex mortgage-backed securities and derivatives at the heart of the crisis will also be much tougher than what the RTC faced in restructuring portfolios of mostly plain-vanilla home loans. "Doing this would be an admission we are in deep, deep trouble," says Setser. But, he adds, "if the situation doesn't stabilize, we have relatively few policy options left."

How much junk remains on the bank books?  The reason for needing action like this indicates things are much worse than admitted. And the amount of toxic assets is also a question. Again, nobody really seems to know but it must be large, and Wilbur Ross’ prediction of 1,000 banks failing under this crisis is being partially confirmed by the government’s newest actions. If it is a cool trillion of toxic assets and the results are similar to the last RTC, the taxpayer will be on the hook for $375 billion. Just for comparison, if the toxic assets were two trillion and the assets were worth $0.20 on the dollar – the taxpayer would be on the hook for a horrific $1.6 trillion dollars. CNBC is reporting the cost at $500 billion.

The cost to the taxpayers for this entire crisis easily could exceed $1 trillion (the new RTC, unrecoverable costs for Freddie (FRE) and Fannie (FNM), FDIC unrecoverable costs, economic stimulus packages, bailout of Bear Stearns, etc).  It is no use to try to fine tune this number as there is a complete void of information to build any accurate estimate.

Using the President’s 2009 Proposed Budget, a few retouched graphs which were in the budget presentation tell the story:

A trillion dollars extra spending adds 7% to the GDP compared deficit.  And what the impact will be in years to follow cannot be defined at this time.

Unfortunately, the baseline assumptions for the 2009 budget have been busted.

Disclosures: none

Comments

[Mr.G]

the outcome of this is simple -all that is happening is this, the banks are passing those losses to the govt -who in turn will turn those losses to the consumer which will in turn come right back to the banks losing money but at greater losses in the future and to every industry in the US - problem is this you dont deal with it now you basically have a depression where cash is king -prices of everything comes down to cash values not leveraged values -and it would really hurt everybody especially wall street and global markets as well -but people on main st would survive though struggle .
what is being done is inflationary and will have the same effect but worse -extremely high interest loans causing negative growth -a devaluation of the dollar where basic neccessities are too expensive -business closures and wall street returns which cant keep up with inflationary pressure or out right losses while inflation is taking place which is worse -my thinking is abandon ship now because at least this way you still have consumers consuming how ever little that will be -where if you bailout out of this little crisis (which has been shown by the federal reserve keeping interest rates down for 2 long time and again ) you will end up with something much bigger in the near future and that I am afraid main street wont be able to survive

2008 Sep 22 07:50 AM

[John Lounsbury]

How about this possible scenario:

1. The government assumes $700 B in non-performing (or poorly-performing) debt.
2. The paper mess is sorted out so that the underlying assets (residential housing) can be identified.
3. The government renegotiates the individual mortgages to reflect the lowered market value and the reduced capacity to pay by the mortgagee.
4. Some people still walk away.
5. The overall result is that housing prices continue to fall because of lowered comps (comparable prices).
6. The government readjusts mortgages further to reflect the continuing decline in housing prices.
7. The spiral continues until new construction completely disappears.
8. The government keeps buying more and more non-performing debt and readjusting the mortage contracts.

The result would be the second "Great Depression". Would it be the final financial event of the U.S.A. as we know it?

Things don't have to go this way, but if we do not recognize the possibility it could become more likely.

2008 Sep 22 10:45 AM

[phdinsuntanning]

the traditional IMF solution: transfer the bad debt to the FED,
eat a 500% devaluation, balance your Federal budget, open
the economy and open hands to foreign investment money
to buy your cheap assets, it works, really. Otherwise zinbawe money coming...

2008 Sep 23 11:44 AM