Can we get an estimate that assumes we nationalize Goldman Sachs, Morgan Stanley, Citigroup, and J.P. Morgan, place them in receivership, selectively default on their derivatives, sell all their assets, and criminally prosecute their executive management from the year 2000 under the RICO statutes?
Bank Bailout Could Cost Up to $4 Trillion: Economists
29 Jan 2009 04:35 PM
The cost of restoring confidence in U.S. financial firms may reach $4 trillion if President Barack Obama moves ahead with a "bad bank" that buys up souring assets.
The figure far exceeds even the most pessimistic estimates of how great the loan losses might be because there is so much uncertainty about default rates, which means the government may need to take on a bigger chunk of bank debt to ease concerns.
Goldman Sachs economists said ideally the public sector would step in to remove the hardest-to-value assets, which would alleviate nagging worries about future losses and hopefully help get lending going again.
"Unfortunately, with an unprecedented meltdown in mortgage credit and a deep recession in the broader economy, there is a great deal of uncertainty about the value of almost every asset," they wrote in a note to clients.
Obama and his economic advisers are expected to lay out their policy plan as early as next week. One idea that seems to be gaining traction is setting up an entity to buy troubled assets and hold them until they mature or resell them.
The hope is that once banks get rid of those bad loans, they can attract private investors, get back to the business of lending, and help revive the economy.
Vice President Joe Biden said Thursday that Treasury Secretary Timothy Geithner was considering all options to restart normal lending, but that no decisions had been made.
Goldman Sachs estimated that it would take on the order of $4 trillion to buy troubled mortgage and consumer debt. That number could shrink if the program were limited to only certain loans or banks, but it could also grow if other asset classes such as commercial real estate loans were included. (How much would it cost if we put Goldman and Morgan Stanley into receivership - Jesse)
New York Sen. Charles Schumer has said that a number of experts thought that up to $4 trillion may be needed to buy the bad assets, an estimate that a Senate aide said was based on informal conversations with people in the industry.
The Wall Street Journal said government officials had discussed spending $1 trillion to $2 trillion to help restore banks to health, citing people familiar with the matter.
At $4 trillion, that would be the equivalent of nearly 1/3 of U.S. gross domestic product. If the government had to fund that amount by issuing additional debt, it would intensify investor concerns about massive supply scaring off demand.
Depending on how the plan is structured, the government may not have to put up the full amount, and since the majority of people are still paying their mortgages and credit card bills, there is a reasonable expectation that taxpayers would recoup a substantial portion of the cost.
However, the potential loss is huge, and if more public money is needed to boost capital even after the bad assets are removed, the total would undoubtedly climb.
The International Monetary Fund said Wednesday that worldwide losses on U.S.-originated loans may hit $2.2 trillion, well above its October estimate of $1.4 trillion. It said banks in the United States, Europe and elsewhere probably needed to raise $500 billion to cover losses coming this year and next.
Cutting Out a Zero
For U.S. lawmakers who are already taking grief from voters over a $700 billion bailout approved last fall, passing another big spending measure carries significant political risk.
At the same time, Obama's team wants to take action that is bold enough to fix the problem once and for all, hoping to avoid the sort of ad hoc approach that has been criticized for adding to investor uncertainty.
Time is not on Obama's side. The more the economy weakens, the longer the list of potentially dodgy debt grows. That is why he faces enormous pressure from Wall Street to act fast.
The government would not necessarily have to spend the full $4 trillion to buy the assets. If it follows the model used in a Federal Reserve program to support consumer and small business loans, the government could potentially put up just 10 percent of the total.
Spending $400 billion would certainly be more palatable to Congress than $4 trillion. It may not even require that much additional funding. Economists estimate that perhaps $250 billion of what remains in the $700 billion bailout fund could be devoted to the "bad bank."
That money could buy bad assets, which would then be repackaged and sold to investors to raise more money which could then by recycled to buy more assets.
Stephen Stanley, chief economist at RBS Greenwich Capital, said although that sounds similar to the sort of financial engineering that spawned the credit crisis in the first place, it would be structured so that the central bank or whichever agency oversees the program is last in line to take losses.
"If things turn out so bad that the Fed ends up on the hook for $1 trillion in losses, then the financial sector, the economy, and everything else will be dead anyway," he said.