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The Financial Crisis: A Big Unknown: Cost of Bailouts --- Profit Is Possible For Government If Firms Do Well
By Sudeep Reddy and John D. McKinnon
1245 words
18 September 2008
The Wall Street Journal
A3
English
(Copyright (c) 2008, Dow Jones & Company, Inc.)
The federal government, now in control of a trio of giant U.S. companies, faces the challenge of managing the troubled firms while trying to protect American taxpayers from losses.
Even as the financial crisis deepened Wednesday, government officials tried to figure out the implications of their $85 billion loan to American International Group Inc., a move that came 10 days after the federal takeover of mortgage giants Fannie Mae and Freddie Mac.
The financial consequences of the government actions will depend on how the companies ultimately perform. Fannie and Freddie are expected to be overhauled and subject to new regulations and oversight. AIG is expected to sell off several business lines, with its ultimate fate uncertain.
When the White House budget office releases its budget proposal early next year, the short-term budget impacts from the bailouts of Bear Stearns Cos., Fannie and Freddie, and AIG could range from zero to tens of billions of dollars, administration officials said. In the context of a 2009 budget deficit that already is projected to reach $500 billion, even big losses could look relatively insignificant. Over the longer term, the government could make money, particularly on the AIG deal.
A slowdown in tax revenue in 2009 could do more damage than the bailouts, a senior administration official said. "The much larger effect is what's going on with the overall economy and the effect on receipts," the official said. "It traditionally has gone up or down by hundreds of billions" based on swings in the economy. "That's what we're most concerned about anytime we estimate."
Calculating the longer-term outlook for Fannie and Freddie, in particular, is "like throwing darts in a dark room," said Sen. Judd Gregg of New Hampshire, the top Republican on the Senate Budget Committee. "No one has any idea what the cost is." He said the new president will face tight fiscal restraints on any new proposals in any case, and those could be made much worse by Fannie and Freddie.
The government interventions are the latest in a series of historic moves to resolve financial crises. The biggest was the government bailout of the savings-and-loan industry that began in 1989 and ultimately cost almost $500 billion. Other rescues led to profits, including a $250 million loan guarantee to Lockheed Aircraft Corp. in 1971; $1.2 billion in loan guarantees to Chrysler Corp. in 1979; and more than $6 billion in cash and loans to airlines in 2001.
"In individual company interventions in the modern era, the federal government generally did not lose money," said Roger Altman, a top Treasury official in both the Clinton and Carter administrations and an architect of the 1979 Chrysler loan. "They were structured very well, and the government's interest was well protected."
Mr. Altman said the structure of the AIG agreement could protect the federal government in a similar fashion. While the U.S. is in a "dangerous financial-market environment," he said, "it is entirely possible that after this interim period the federal government ultimately is repaid."
Key questions and complications remain. Treasury Secretary Henry Paulson installed a new chief executive at AIG; Mr. Paulson's level of involvement, and that of his successor come January, isn't clear. Federal Reserve Chairman Ben Bernanke and other top officials presumably will be forced to spend considerable time overseeing the AIG loan while also handling monetary policy. And the exit plan for the government, and the taxpayer, is unknown.
Treasury and Fed officials "are doing what they have to do to keep the dominos from falling, and I support it," said Rep. John Spratt, the chairman of the House Budget Committee. "But the outlays are getting pretty big."
He said recurring federal-budget deficits already have raised alarms with foreign investors; that is one reason the government had to move decisively.
The Fed and Treasury devised the AIG loan package, which provides as much as $85 billion to the insurance giant, with only a couple of days of planning. They rushed to avert potentially disastrous consequences in financial markets. In return, the Fed took an equity stake of nearly 80% and is charging the company a high interest rate -- 8.5 percentage points above the London Interbank Offered Rate. The loan is designed to allow AIG to finance itself while selling off businesses.
The term of the loan -- two years -- indicates that the government designed the package to force the insurer to liquidate as quickly as possible, said Tom Gallagher, an analyst at ISI Group in Washington. "The risk is higher the longer-term the arrangement is," he said.
The government's role in handling the two mortgage giants is likely to be more political. Lawmakers are discussing how to protect some homeowners by modifying mortgage loans and minimizing foreclosures.
Fannie and Freddie own or guarantee more than $5 trillion of mortgages, underpinning the nation's housing market. The government's actual cost of bailing out the mortgage titans could be relatively small next year if the housing market doesn't deteriorate significantly.
But lawmakers also are mulling over worst-case scenarios from some analysts who say the government's exposure might be as much as $300 billion if the housing market fails to recover -- an amount that could damage the government's finances just as the fiscal pressure from baby-boomer retirements begins.
Given the uncertainties surrounding the bailouts, "this is a coin flip," said Robert Reischauer, who was director of the Congressional Budget Office during the savings-and-loan crisis in the late 1980s and early 1990s.
This time around, doubts arise from the economic outlook, as well as the actions of the federal government, international investors and other players. "There's obviously a lot more uncertainty about who's going to step in and backstop the system," said Mr. Reischauer, president of the Urban Institute, a Washington think tank. "There was no question with the S&L's." This crisis could be worse, he said, especially if international investors decide to pull back.
The reason for some optimism over the AIG deal is that the $85 billion loan is backed by some strong collateral: AIG's insurance businesses. It also carries a high interest rate. The government's 79.9% equity stake could turn a profit if the company rebounds.
In the case of the Bear Stearns bailout in March, the government accepted less-robust mortgage-backed securities as collateral for the $30 billion it offered to facilitate Bear's takeover by J.P. Morgan Chase & Co. Those assets could perform well, depending on the strength of the economy and the housing market over the next several years. In addition, J.P. Morgan is on the hook for the first $1 billion in losses, softening the blow to the government if the mortgage assets don't do well.
For a second straight day, President George W. Bush kept a low profile on the crisis.
"There are times, believe it or not, when policy makers actually need to, like, work on making some policy," said White House press secretary Dana Perino, explaining Mr. Bush's public silence. Mr. Bush sought to reassure the public Monday, but his comments appeared to have little effect on markets.
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i'd post a link to the source but i copied it from factiva.
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“Secret Government” Running Economy
