Is the Government Bailout Really Going to Cost Taxpayers $700 billion?

publication date: Sep 22, 2008

Will the $700 billion "bailout" help or harm the U.S.?

With all the other money that our government is borrowing, can we really afford this cost? While the stock market rallied initially after the plan was proposed, it then dropped. Do people and the market really want this and is it the best solution?

Let me clear up some misperceptions that have been perpetuated by some in the media and others. This program, which was designed primarily to remove sub-prime loans from the books of financial institutions, is not going to "cost" the federal government or taxpayers $700 billion. That is simply the amount of Treasury securities which the Treasury department has asked for permission to issue to buy troubled assets. If these assets had no value, then $700 billion would be the cost.

This troubled assets purchase plan is modeled after the Resolution Trust Corporation (RTC) which allowed the federal government to acquire and then sell off more than $450 billion of distressed real estate assets including loans during the Savings & Loan Crisis in the late 1980s and early 1990s. According to the FDIC, the cost to the taxpayer of the RTC was $76 billion.

There were skeptics for the original RTC plan on many fronts: how long it would take, cost and likely success. A 2007 FDIC Banking Review article reflecting on the RTC said, "When the RTC opened for business, some observers predicted that their grandchildren would be buying assets from the agency. Perhaps a measure of the RTC's success is that little more than a decade after it closed, this agency that provoked so much debate is now largely forgotten."

In speaking with economists, banking and investment industry experts, the most substantive concern I've heard about this new plan is that it could have been minimized or even eliminated had there been a modification of banking accounting rules. "70 percent of the financial industry problems we're seeing today are due to the mark-to-market accounting's the worst thing in the world but the best thing we got," says Brian Wesbury, Chief Economist with First Trust.

Wesbury argues that plunging prices for sub-prime mortgages in secondary markets forced financial institutions to drastically lower the valuations for such loans that they held. This mark-to-market accounting forced these institutions to raise more capital which became increasingly difficult and costly for many companies to do and was impossible for others which ultimately led to bankruptcies (Bear Stearns and Lehman), government intervention and ownership (AIG, Fannie Mae and Freddie Mac) and arranged marriages/mergers (Merrill Lynch).

Merrill Lynch, for example, unloaded a bunch of sub-prime loans earlier this year for a mere 22 percent of their original value. Clearly, such fire sale prices don't accurately reflect the ultimate likely value of these mortgages. "Even if all of these loans went bad through foreclosure, they'd still get at least 40 cents on the dollar at the worst," says Wesbury. Of course, not all loans will end up in foreclosure and for properties and loans going that route, the underlying real estate has value, albeit reduced, which will be realized.


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Eric Tyson is the only best-selling personal finance author who has an extensive background as an hourly-based financial advisor and who does not accept speaking fees, endorsement deals or fees of any type from companies in the financial services industry or product or service providers recommended in his articles, books and his publications.