New Bailout Price Tag: $2.25 Trillion Dollars
On Monday, I said that the total cost of this bailout could scale up to $3 trillion -- I just didn't imagine it would happen by Wednesday.
We learned yesterday that the size of the bailout just tripled, from $750b to $3T. Here is the cost structure:
• $250 billion of capital into banks;
• Guarantee $1.5 trillion in new senior debt issued by banks;
• Insure $500 billion in deposits in noninterest-bearing accounts (primarily businesses accts).
In exchange for this largesse, the treasury, on behalf of taxpayers, receives:
• Preferred shares that pay a 5% (rising to 9% after five years);
•No voting rights for government;
• Warrants to purchase common shares = to 15% of initial investment
All told, its a massive program that makes my earlier forecast of 2-3Trillion obsolete. New forecast is now double: $4-6 trillion dollars . . .
More details at articles below . . .
Sources:
Drama Behind a $250 Billion Banking Deal
MARK LANDLER and ERIC DASH
NYT, October 14, 2008
http://www.nytimes.com/2008/10/15/business/economy/15bailout.html
Bailout Critic: Plan Could Cost $3 Trillion
ALICE GOMSTYN
ABC NEWS Business, Oct. 13, 2008
http://abcnews.go.com/Business/Economy/story?id=6022145&page=1
Americans Embrace Big Government to Help Solve Market Crisis
Edwin Chen and Matthew Benjamin
Bloomberg, Oct. 15 2008
http://www.bloomberg.com/apps/news?pid=20601070&sid=alhCRwBpIK0U&
Devil Is in Bailout's Details
Government's $250 Billion Cash Injection Sparks Welter of Issues
DEBORAH SOLOMON and DAVID ENRICH
WSJ, OCTOBER 15, 2008
http://online.wsj.com/article/SB122398468353632299.html
Wednesday, October 15, 2008 | 11:00 AM | Permalink
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Comments
I wonder if Cheney's heart difficulties this morning are from the sudden realization that deficits do matter, but his moment of epiphany just happens to be a tad late.
Posted by: Stuart | Oct 15, 2008 11:09:16 AM
For some reason I'm reminded of the old Andrew Dice Clay one-liner: "Little boy blue.....He needed the money!"
Posted by: Scott in Chicago | Oct 15, 2008 11:09:42 AM
The other question is, how will this be accounted for when assessing the budget deficit?
Will the government use “mark to market” accounting, or “mark to model”…?
Posted by: DL | Oct 15, 2008 11:11:32 AM
Each trillion seems to bump up 10 treasury rate by about 10 basis points. So, per your estimate of $5 trillion, we've climbed from 3.6 to close to 4.1. Of course, each tick up in rates makes borrowing less likely and defaults more so, which in turn pushes up the bailout tab. Yikes!
Posted by: adam | Oct 15, 2008 11:21:51 AM
The Chen and Benjamin article is just what is wrong with the press...
Americans embrace big government to help solve market crisis.
I read the article. A more apt headline would have said:
Americans Hope Government Will Help Solve Market Crisis...
Embrace and Big are just emotional tag words to help improve readership...
Humbug...(But it is another beauuuuutiful day here in East Tennessee)
Posted by: Bruce in Tennessee | Oct 15, 2008 11:27:44 AM
What I don't understand is how, even with Super Bear Roubini updating his most pessimistic forecast to a total debt-related loss of $3 trillion, we need to spend MORE than that to rescue the system?
If Roubini is right, and credit related losses are $3 trillion, shouldn't $3 trillion clean the entire mess up? What am I missing? Is it the multiplier effect that banks have?
By the way, when you take the global amount pledged to clean up the system, as of yesterday it was 3.3 trillion. The U.S was at 1 trillion (250B already spent on AIG, FNM, FRE and 750B in the rescue package) and 2.3T from the rest of the world. If the US portion goes up as much as BR says, the global number is nearly TWICE the maximum loss amount that Roubini fears.
Barry, maybe you could address why the bailout packages have to be so large that they outstrip Roubini's worst case expectation for losses.
Posted by: Don | Oct 15, 2008 11:31:03 AM
$3 trillion. Poof.
It's not very comforting at this stage of the game to find out that Paulson was John Ehrlichman's assistant in 1972 and 1973.
Posted by: me | Oct 15, 2008 11:44:06 AM
"• $250 billion of capital into banks;"
That was the easy part. Now they have to figure out how to force banks to lend and citizens to take on more debt. Pathetic!!
Posted by: Pat G. | Oct 15, 2008 11:45:35 AM
There's no reason for you to be as sloppy as ABC news. The word you want is 'price,' not 'cost,' which will be the net of your first set of bullets minus your second set. I'm sure if I were to say FNM/FRE are going to cost the taxpayer $3T, you'd go ballistic. Disclaimer: I'm deeply unhappy about both sets of bailouts.
Posted by: Namazu | Oct 15, 2008 11:46:52 AM
When the government guarantees debt how is this an expense? There is a cost and an obligation but the total costs you've portrayed would only happen if everyone of the guarantees goes insolvent with no liquidation value.
I suspect the true cost is far less than $2.25 Trillion.
Care to elucidate?
Cheers,
Marc
Posted by: Marc | Oct 15, 2008 11:52:57 AM
Namazu
Cost isn't the first bullets minus the second. Cost is unknown.
The "price" is only the $250billion equity purchase, plus whatever value might be imputed to the bond guarantees. As I understand it, the deposit guarantee program is to be premium funded after a 30 day "free trial".
The ultimate cost is unknowable, and will depend on, among other things, the terminal value of the pref shares, and the losses (if any) on the debt guarantees.
I'm not an apologist for any of these bailouts, but let's stick to the facts.
Posted by: Estragon | Oct 15, 2008 11:58:28 AM
I thought that by now I would be getting used to this (desensitized). I still get queezy when I read these kinds of articles -
http://news.yahoo.com/s/ap/20081015/ap_on_bi_ge/financial_meltdown
http://online.wsj.com/article/SB122402768546534409.html?mod=article-outset-box
Posted by: Bill | Oct 15, 2008 11:59:16 AM
This is why government intervention cannot work! For one, they distort the market by making normal lending prudence irrelevant by guaranteeing loans. Then the sticker price increases, because it's not their money, and politics dominates the decision making process. The purchasing power of the dollar is going to plummet once this added liquidity starts getting used and banks start lending again. Be sure to invest in something that will outpace the rate of inflation, or you will find yourself with nothing and left holding the bag.
The Truth Shall Set You Free - There goes the value of your dollar
Posted by: Truth08 | Oct 15, 2008 12:02:43 PM
Any of you think this is going to eventually effect inflation and consequently be good for inflation linked bonds?
Posted by: John | Oct 15, 2008 12:16:11 PM
In an era of “creative destruction”, here is Schumpeter’s warning:
Schumpeter's theory is that the success of capitalism will lead to a form of corporatism and a fostering of values hostile to capitalism, especially among intellectuals. The intellectual and social climate needed to allow entrepreneurship to thrive will not exist in advanced capitalism; it will be replaced by socialism in some form.
Posted by: lithuania | Oct 15, 2008 12:17:36 PM
Funny:
Bush Calls For Panic
OCTOBER 15, 2008 | ISSUE 44•42
WASHINGTON—In a nationally televised address to the American people Wednesday night, President Bush called upon every man, woman, and child to spiral uncontrollably downward into complete and utter panic.
http://www.theonion.com/content/news/bush_calls_for_panic
Best regards,
Econolicious
Posted by: ECONOMISTA NON GRATA | Oct 15, 2008 12:19:15 PM
Perhaps Paulson and company are forcing cash into the banks so that when hedge funds unwind or more Lehman "like" guarantees come (.91c on the dollar losses) happen they have the funds to pay back?
Posted by: JohnW | Oct 15, 2008 12:35:01 PM
Cost of preferred purchases would be the value of the subsidy, if any, provided to preferred issuers via being charged a below market rate. This subsidy is theoretically offset by the value of warrants and decreased risk of systemic meltdown.
The cost of insuring bonds and deposit accounts is equal to the premiums received plus imputed interest earned on unearned premiums & reserves less losses incurred.
Bottom line: if the bailout is priced and administered properly, the cost may be minimal. Unfortunately, the gov't is not pricing these products to account for individual risk. The government will necessarily suffer adverse selection and incur more losses than it should. Any insurance company that would price business that way would go quickly bankrupt.
That said, other commenters are right. The cost will be substantially less than $3 trillion. The concept of the bailout is good. The pricing scheme is questionable.
Posted by: craner | Oct 15, 2008 12:38:50 PM
Roubini is right for the wrong reasons. The $3 trillion number is based on faulty logic. And, his underlying premise for the cause of this crisis is wrong.
Posted by: bdg123 | Oct 15, 2008 12:39:29 PM
Schumpeter lifted that perspective from Marx.
Posted by: bdg123 | Oct 15, 2008 12:41:46 PM
No doubt a lot of this money will be recouped at some point. But what happens to the money then?
To some new spending program.
And the politicians will start “counting the chickens” before they hatch.
Posted by: DL | Oct 15, 2008 12:43:56 PM
Are you all certain that Paulson did not work for Spiro "May I Have the Envelope, Please" Agnew?
He seems like a bag man to me.
Posted by: esb | Oct 15, 2008 12:53:57 PM
The basic principle that has been agreed to is committing future taxpayer work into present bailouts for the 'right people'.
The obvious next step is the realization that there is now too much overhang on the taxpayer and future investment will be crimped. Therefore, all countries who are now doing this giveaway will look to the inflation tool to dimish the debt.
Protect yourself.
Posted by: wally | Oct 15, 2008 12:56:09 PM
Paul Kedrosky was on CNBC this morning countering the usual cheery faces, he was excellent, by the way. Darda was on as well, being bearish, but since he is almost always wrong....
Rick Santelli was pointing out that he has been right on the major moves of the $ this year and also states that we have seen the low yield for the year in the 5- and 10-year. I bet he is long gold and short the 10-year.
Bretton Woods would be a great place to agree to go back on the gold standard, don't you think?
Posted by: leftback | Oct 15, 2008 1:05:16 PM
Three weeks ago, I had a now forgotten debate with Douglas Watts and wunsacon (both more or less liberal thinkers, by the way) on the Democrats having been "politically trapped" by the Bush Administration to go along with the bailout:
http://bigpicture.typepad.com/comments/2008/09/baillout-plan-t.html
Can you imagine if the Dems had fought the bailout and the stock market caved as it did anyway (even if I still think this crash sucks so far)? Obama would have been toast.
My point here is that (a) Paulson could have probably asked for $10 trillion and gotten what he wanted...we taxpayers may have gotten off lightly given the historic extortion tactics of Disaster Politics, and more importantly, (b) I was right.
Posted by: CNBC Sucks | Oct 15, 2008 1:07:34 PM
