As Senator Everett Dirksen once said, “A billion here, a billion there, and pretty soon you’re talking real money.”
Although the powers that be have relied mainly on guarantees and loans rather than explicit payment to try to prop up financial institutions and the housing market, the same principle applies. Even though these commitments are contingent liabilities, the amounts are so large and the risks assumed are sufficiently dodgy that there is certain to be some payment to the piper.
An article in Bloomberg makes a first cut.
Even as the Bush administration insists it won’t risk public funds in a bailout, American taxpayers may already be liable for billions of dollars stemming from Federal Reserve and Treasury efforts to quell a financial crisis.
History suggests the Fed may not recover some of the almost $30 billion investment in illiquid mortgage securities it received from Bear Stearns Cos., said Joe Mason, a Drexel University professor who has written on banking crises. Treasury’s push to have Fannie Mae and Freddie Mac buy more mortgage bonds reduces the capital the government-chartered companies hold in reserve at a time when foreclosures and defaults are surging.
Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson were forced to respond after capital markets seized up and Bear Stearns faced a run by creditors. In an emergency action that jeopardizes the dividend it pays the Treasury, the Fed authorized a $29 billion loan against illiquid mortgage- and asset-backed securities from Bear Stearns that will be held in a Delaware corporation. JPMorgan contributed $1 billion.
The Delaware company will liquidate the assets over 10 years, with JPMorgan absorbing the first $1 billion in losses, with the Fed bearing any that remain. Any such losses would hurt the Fed’s balance sheet, and ultimately the taxpayer, because they would reduce the stipend the Fed pays to the Treasury from earnings on its portfolio. The dividend was $29 billion in 2006.
“The fact that Treasury and Congress have been unwilling or unable to be proactive and provide a solution that involves putting taxpayer money at risk means that the Fed has had to take more measures itself, also putting taxpayer money at risk,” said Laurence Meyer, a former Fed governor, and now vice chairman of Macroeconomic Advisers LLC in Washington….
The average recovery on failed bank assets is 40 cents on the dollar over a six-year period, according to Drexel’s Mason, a former official at the Treasury’s Office of the Comptroller of the Currency. Nobody knows if that historical benchmark will hold for the Fed portfolio because the assets haven’t been disclosed, they have already been marked down and the Fed has 10 years to recover value.
“Over 10 years, you might eventually get your money back,” said Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago.’
Still, “that isn’t costless to the Fed, it isn’t the same as holding Treasuries,” she said. On some low-documentation loans, “you are going to be lucky to get 40 percent.”
Paulson reversed Treasury’s stand of the previous three years in approving the decision to direct Fannie Mae and Freddie Mac to expand their $1.5 trillion mortgage assets. Previously, Treasury and the Fed had called for cuts in the portfolios held by the government-chartered companies.
Fannie Mae and Freddie Mac will buffer against more risk by raising “significant” capital, Fannie Mae Chief Executive Officer Daniel Mudd and Freddie Mac Chief Executive Officer Richard Syron said at a press conference with James Lockhart, director of the Office of Federal Housing Enterprise Oversight that regulates the two companies.
The companies reported record fourth-quarter losses totaling $6 billion and warned days before announcing the additional purchases that credit losses will rise this year.
Lockhart dismissed the view that taxpayers could be liable for such losses. “Certainly not,” he said. The companies “have the capital, they support their own” mortgage-backed securities.
Yet the Treasury’s authority to buy $2.25 billion in each of the companies’ securities has created investor expectations that the firms hold an implicit federal guarantee against losses.
Lenders allow Fannie Mae and Freddie Mac to borrow more cheaply than rival companies because they expect Treasury would provide a bailout before letting them default.
Because Fannie Mae and Freddie Mac own or guarantee about 40 percent of the $11.5 trillion home loan market, the cost of a bailout would be “in the hundreds of billions of dollars,” said Andrew Laperriere, managing director at International Strategy & Investment Group in Washington. “Taxpayers should be increasingly concerned about the contingent liability.”