& Market Trends
How Much Will Government
Bailouts Actually Cost the American Taxpayer?
Aug 12, 2008
Over the last eight years,
we have watched in horror as a two-term Republican Administration
furthered programs that have effectively thrown lit sticks of
dynamite into our American factories. These programs have dismantled
entire industries in the United States and encouraged their growth
in China and elsewhere in Asia because of cheap labor. Also,
during this time the illusion of prosperity was maintained by
a Greenspan Fed as interest rates were cut to record lows, and
a disastrous housing bubble was created. Americans were so seduced
by home ownership that they bought houses in a frenzy that they
couldn't afford, and then borrowed against them. In addition,
under the Administration's policies, the value of the dollar
has been trashed, and commodity inflation has robbed workers
lucky enough to still have jobs.
As the unprecedented credit
crisis continues into its second year, it's becoming crystal
clear that the American economy is slipping into the worst post-WWII
recession on record. It's even beginning to dawn on third and
fourth generation Wall Street Republicans that if the average
American doesn't have a good job (much less any job), they won't
be able to pay their mortgage, auto loan or credit card.
For now, Fannie Mae and Freddie
Mac have been essentially nationalized and the Federal Reserve
has been turned into a dumping ground for toxic waste mortgage
securities beginning with the Bear Stearns bailout.
What is this economic disaster
going to cost the taxpayer? Let's try to add it up.
The Federal Reserve: The Fed swapped out Treasuries for
tens of billions in mortgage securities it now holds on its books.
It's highly likely that these securities will not hold their
value. Of course, Bear Stearns was just the first major financial
institution failure requiring a bailout, but there will be more.
Let's say the Fed gets stiffed for $10 billion, a modest sum.
That translates into $10 billion less in profits from the Fed
to send the US Treasury, and $10 billion more for the taxpayer
Student Loans: With the capital market seizing up,
if you need a loan to go to college or graduate school, the federal
government has already become the lender of last resort. We estimate
that several hundred billion of student loans are outstanding,
and the average debt per student is $20,000. Education is in
the national interest and very important, but with unemployment
rising and jobs for new and old graduates vanishing, many student
loans simply cannot be paid back at this time. One day the old
loans may get paid, but for the next few years new loans will
not be funded by repaying old loans. These loans will have to
be funded directly by the US government borrowing the money.
Conservatively, put the cost down at $20 billion.
Pension Benefit Guarantee
Corporation: This government
agency insures $2.5 trillion in Defined Benefit obligations.
The PBGC covers 30,000 business plans and 44 million workers.
The PBGC charges an insurance fee and has $55 billion in assets.
Unfortunately, the Bush Administration wanted to give the stock
market a boost and forced the PBGC to move from mostly safe bonds
into 45 percent equity holdings, a move that occurred just before
the stock market really headed down. The PBGC is already $14
billion under-funded, and that's before the recession smashes
the stock value of their portfolio. Many U.S. businesses will
continue to fail, taking down with them thousands of insured
but under-funded pension plans. When Wall Street gets bailed
out, don't you think Congress will bail out workers' pensions?
Let's put the cost to the taxpayer at a conservative $30 billion.
Federal Housing Administration:
Cynics thought that
the FHA was a way to give the poor a house to live in that they
didn't have to pay for. Well, it looks like the cynics were right!
The FHA has given insured single-family mortgages to about five
million people and 17 percent (or one in six) are delinquent.
These catastrophic losses represent the worst of "cash for
trash" lending that is crushing financial institutions in
subprime. It also means that you, the taxpayer, are paying for
about one million people in the FHA program to live rent free!
Even with some of the loans swapped into Fannie & Freddie,
now that those entities are backed by the taxpayer, you can't
avoid the cost. Conservative cost is $20 billion.
Small Business Administration:
Who can vote against
socialism for small business? In the last few years, private
credit was so easy to obtain that anyone who could sign their
name to a piece of paper could get a loan from a bank or finance
company. It's actually astounding that the SBA could continue
to find borrowers that had been turned down by the private sector.
At the end on 2007, the balance of these SBA loans totaled $235
billion, with cumulative losses of about six percent. But don't
let history of only 6 percent losses fool you. As the economy
turns down, many of the businesses with SBA loans will fail.
For now, let's put this bill at a $20 billion loss.
Federal Home Loan Banks:
The FHLB's balance
sheet is about the size of another Fannie Mae or Freddie Mac.
The 12 banks of the FHL Bank system are owned by over 8,000 financial
institutions and provide low-cost funding for home mortgage loans
and small business. These are the loans that don't qualify for
Fannie or Freddie lending programs, which means they're really
The FHLB has over $1 trillion
in assets, but what are these assets really worth? Well, a lot
of mortgages that went into the collateral are Alt-A loans (interest
only, no income verification, principal deferred). Alt-A loans
are already tracking a 12 percent delinquency. Some of the big
name borrowers from the FHLB are Countrywide, WaMu, Downey, and
other banks headed into FDIC receivership. With only four percent
capital, the FHLB can be crushed by losses. The real challenge,
though, will be between the FHLB and FDIC as they fight to determine
who gets stuck with the losses when the banks, thrifts, and credit
unions fail. Either way, we'll foot the bill. Let's put this
one down for $50 billion, which is only five percent of the assets
of the FHLB.
Federal Deposit Insurance
Corporation: The FDIC
and Controller of the Currency are directly inside the US Treasury.
The FDIC has already started mopping up bad banks and merging
their deposit-gathering branches into the surviving banks. It's
estimated that just the Indy Mac failure alone will cost the
FDIC at least $5 billon (or ten percent of its loss reserves
of about $50 billion). Even if a large portion of the bad single-family
mortgage debt can be pushed back into the FHLB or over to Fannie
Freddie, total losses on construction, commercial properties
and consumer loans will easily cost the FDIC, and therefore the
US taxpayer, $100 billion.
What's really scary is that
the head of the FDIC has told Indy Mac not to foreclose on delinquent
homeowners until the loans are 300 days past due. If the government
encourages people not to pay their mortgages and live rent free
at our expense, we'll need to increase the expected FDIC bill
to the American taxpayer to $150 billion.
Fannie Mae and Freddie Mac:
In 2007, there were
over 2 million notices of foreclosure in the United States, and
in 2008, foreclosures could reach 3 million. Fannie &
Freddie account for 44 percent of the foreclosed loans! So, should
it be any surprise that these two giants (that hold or insure
over $5 trillion in mortgage loans) just announced they also
will not even think of foreclosing on anyone for at least 300
days! Does the federal government really believe that by not
foreclosing, the losses will be minimized?
Meanwhile, the new law pushed
through by the US Treasury guarantees the debt of Fannie &
Freddie. Fannie & Freddie each have about $1 trillion on
their balance sheets, and they also insure about $3 trillion
in GSE agency securities that pass-through mortgage interest
and principal on a pool basis to owners of the securities. The
new law puts an explicit government guarantee behind the GSE
debt, including every pass-through security. This means all mortgage
payments must be made on time to investors, even if any mortgages
in the past-through security are delinquent.
With a record number of homeowners
considering whether to live free for 300 days by skipping their
mortgage payments, imagine the cash gap that will open up between
the cash that comes into Fannie & Freddie from mortgage payments,
and the cash that must go out to cover the GSE security payments.
For the government, it is more important to spread the losses
into the future than to minimize them. Losses on defaulted
mortgage loans at the GSEs will be horrible. Put the bailout
cost at $300 billion.
Let's tally it up (see table
The financial institution bailouts
and the government taxpayer bailouts are looking more like socialism
every day. I suspect that when we look back at this time in history
four years from now, and marvel at the great increase in government
ownership and socialism imbedded in the economy, we will have
the Bush Administration to thank for sending us down the road
to economic serfdom.
Aug 11, 2008
Finance Group, LLC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
Richard Benson, SFGroup, is a widely-published
author on securitization and specialty finance, and a sought after
speaker at financing conferences on raising equity for mid-market
Prior to founding
the Specialty Finance Group in 1989, Mr. Benson acted as a trading
desk economist for Chase Manhattan Bank in the early 1980's and
started in the securitization business in 1983 at Bear Stearns,
and helped build the early securitization businesses at Citibank
and E.F. Hutton.
Mr. Benson graduated
from the University of Wisconsin in 1970 in the Honors Program
in Math, and did his doctoral work in Economics at Harvard University.
Mr. Benson is a member of the Harvard Club of New York and Palm
Finance Group, LLC is a Florida Limited Liability Company and
is registered with FINRA/SIPC as a Broker/Dealer.