Calculating the Cost of Bailouts

A recent New York Times includes a piece on the Treasury’s study of the various bailouts or “rescues” of distressed financial and other institutions.  Gretchen Morgenson, Seeing Bailouts Through Rose-Colored Glasses, New York Times (May 19, 2012).

The Treasury study, The Financial Crisis Response–in charts (April 13, 2012), is  positive about the way that government handled the bailouts. 

Collectively, these programs –carried out by both a Republican and a Democratic administration–were effective in preventing the collapse of the financial system, in restarting economic growth, and in restoring access to credit and capital.  They were well-designed and carefully managed.  Because of this, we were able to limit the broader economic and financial damage.  Although this crisis was caused by a shock larger than that which caused the Great Depression, we were able to put out the financial fires at much lower cost and with much less overall economic damage than occurred during a broad mix of financial crises over the last few decades.

Reading that, one might conclude that everybody now is sitting fairly pretty, and that it was all done in a very upfront, fair and damage-free way.  That ignores the fact that the bank bailouts treated the banksters with kid gloves–letting managers continue to receive their customary overcompensation and allowing banks generally to continue their predatory practices even while the taxpayers were providing them extraordinarily low-cost financing with practically no strings attached.  Meanwhile, ordinary Americans–especially those in the lower half of the income distribution–suffered enormously.  Congress–at the behest of the banksters–refused to enact mortgage clawback provisions in bankruptcy, the one law that would have done wonders at saving families and neighborhoods from unprecedented deteroioration and blight.  

To be fair, the report does include a bevy of charts that attempt to show how the crisis played out for the banks, the economy in general, and ordinary Americans (unemployment, depressed home sales market, etc.).  But then the Treasury goes on to claim the following:

[T]he latest available estimates indicate the financial stability programs are likely to result in an overall positive financial return for taxpayers in terms of direct fiscal cost.  These estimates are based on gains already realized and on a range of different measures of cost and return for the remaining investments outstanding.  These estimates do not include the full impact of the crisis on our fiscal position.  And they do not include the cost of the tax cuts and the emergency spending programs passed by Congress. 

Now, it is good to know that at least the “direct fiscal cost” of the bailouts is likely to be positive.  But note the gaping hole between that amount and the overall true cost of the bailouts–the “impact of the crisis on our fiscal position” and “the cost of the tax cuts” and “the emergency spending programs.”  Now, at least the emergency spending programs generated economic activity and made real differences for individual people a good number of whom one can assume weren’t in the top 1%.  The tax cuts are a big cost item and one that may well not have had the benefits assumed, except for those that went to the lower and lower-middle income working classes (such as the payroll tax relief).   And the impact on our fiscal position is ongoing and still strongly felt, as we struggle to rebalance an economy that already consumed too much from outside and produced too little here at home.  So how much comfort can we take from the idea that the direct fiscal cost may be significantly less than some had initially expected it to be?

Here’s where the Times story comes in. Morgenson notes that “As the battles over financial regulationrage in Washington, it’s crucial that American taxpayers understand the costs associated with rescuing behemoth institutions.”  We cannot take wise action for or against reduction in size of banks or other issues unless we are dealing with full information about the crisis and its aftermath.  That won’t be easy in the politicized environment in which the Obama administration understandably wants to showcase how its efforts have helped the economy and the GOP seens intent on a “my way or the highway” approach to governance that cares more about winning a race than about doing what’s good for the people.

Morgenson reports on an interview with Edward Kane, Boston College finance professor and economist, who thinks that the public needs to see a more thorough cost-benefit analysis of the TARP and other expenditures.  Kane calls the analysis “deficient” (one might even say misleading) for counting as gains the interest income the Fed made from holding Treasuries (this is like money passed from mom to dad to put in the allowance jar for the kids–in other words, Treasury interest is paid by the US fisc to the Fed, and the Fed’s profits are paid into the US fisc, so it’s all the same pot).  But the bigger deal is a genuine evaluation of the opportunity cost of the subsidy provided to bailout recipients.

The programs provided enormous amounts of money at below-market terms for extended periods, he said. Had those guarantees been priced at their true market value — what a private investor would have charged to lend during those dire days — taxpayers should have received far higher returns. Morgenson, Seeing Bailouts Through Rose-Colored Glasses

Charles Calomaris, a Colombia Business School prof and NBER research associate who worked with Kane on the study, noted the cost-benefit concern.

“We are not saying that the benefits weren’t there,” Mr. Calomiris said. “We’re not saying that it wasn’t worthwhile to create these programs. Maybe it was, maybe it wasn’t. But it requires a fuller analysis of what the benefits were.” Morgenson, Seeing Bailouts Through Rose-Colored Glasses

Read more at A Taxing Matter