The U.S. Treasury Department wants the public to believe the government’s bailouts of the financial sector might make money for taxpayers. It’s easy to see why.
If the government could show an overall profit, the implication would be that bailouts must be a good thing. Put aside the moral hazard they create, by encouraging reckless behavior. Never mind that the country’s largest too-big-to-fail banks are larger today than when the financial crisis began in 2007. The leaders who pulled off this amazing feat would deserve our praise, and everything will have worked out for the best -- or so goes this line of thought.
Whatever logic there is to this reasoning falls apart, however, if the prospect of future gains is false. And sure enough, it probably is.
The Treasury Department a week ago released its latest cost estimates for the government’s numerous crisis-response programs. “Overall, the government is now expected to at least break even on its financial stability programs and may realize a positive return,” the report said. Unfortunately this conclusion rests heavily on wishful thinking and creative accounting, which becomes obvious when you dig into the report’s footnotes.
Behind the Numbers
Here’s a breakdown of the numbers. The report, citing White House budget office figures, estimated $46 billion of costs under the Troubled Asset Relief Program to support struggling homeowners. It showed $2 billion of overall gains on the Treasury’s investments in various bailed-out companies, such as American International Group Inc. (AIG), some of which are held outside of TARP. Other Treasury programs to buy mortgage-backed securities and to guarantee money-market funds would produce $26 billion of gains, the report said.
Add up those categories, and the projected net cost so far is $18 billion. On top of that, there’s the current net cost of the government-sponsored housing financiers Fannie Mae and Freddie Mac, which the Treasury pegged at $151 billion. So how did Treasury project a potential gain overall?
First the Treasury counted $179 billion of so-called excess earnings from the Federal Reserve as a gain. The report said this figure represented amounts “above what would be expected in normal times,” and included $82 billion collected through fiscal 2011 as well as estimated gains through fiscal 2015. Second, the report included a White House budget projection showing the net cost of the Fannie and Freddie conservatorships would fall 81 percent to $28 billion by fiscal 2022. Put another way, the projection envisions record profits at the two companies for years to come.
Those numbers are where the report starts to get loopy. When the Fed remits profits to the Treasury each year, to a large degree it is refunding money to the government. In fiscal 2010, the latest year for which the Fed has published an annual report, the bulk of the Fed’s earnings consisted of interest income on securities issued or guaranteed by the government and government-sponsored enterprises such as Fannie and Freddie.
For instance, say the Fed collects interest on the Treasury bonds it holds, and later returns this money to the Treasury in the form of an earnings distribution. The payments from the Fed eliminate an expense for the Treasury. But to call them a gain for the Treasury is circular. The Treasury hasn’t made a profit. The transactions are a wash, economically. Similarly, the main reason Fannie and Freddie have been able to meet their obligations is they keep borrowing more money from the Treasury.
As for the declining Fannie and Freddie cost projections, the Treasury is relying on a forecast that in essence has the two companies generating $123 billion of earnings over the next 10 years. This would be nice, except there’s no basis for believing it will happen. The companies have reported losses every year since 2007. During the previous 10-year period from 1997 to 2006, which included the housing boom, their combined earnings were only $82 billion.
Think back 10 years ago to 2002. Was the government predicting then that Fannie and Freddie each would get embroiled in accounting scandals within two years, and go broke in 2008? Of course it wasn’t. The Treasury report did include a disclaimer that the forecast “could change materially depending on future changes in home prices, enterprise market share, and other operating assumptions.” That’s a gross understatement. The forecast is a fantasy -- a number pulled from the air.
Plus, there were all sorts of other bailout programs the Treasury report didn’t include in its estimates, such as increases in mortgage guarantees by the U.S. Federal Housing Administration. What’s clear is that the Treasury’s objective wasn’t to show a true measure of costs. It was to find a way to show a potential gain to taxpayers, by any math necessary.
We’ve been down this path before. A great example can be found in a 1998 case study by the Federal Deposit Insurance Corp. of the government’s 1984 bailout of Continental Illinois National Bank & Trust Co.
When the agency finally sold the last of its ownership stake in 1991, it “produced a net gain to the FDIC of $200 million in excess of the $1 billion capital investment originally provided to Continental,” the study’s authors wrote. Dividend income amounted to an additional $202 million. There also was a downside: “The Continental open bank assistance transaction affirmed for many the notion that certain banks were simply ‘too big to fail.”’
Although that deal showed a profit, the gain excluded the future costs to society that come with moral hazard. We’re still paying the bill.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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