The Congressional Budget Office (CBO) wrote a letter on how much the proposed bailout for Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLB) would cost. The letter is simply a measure to cover up the big money the taxpayers will have to pay for this.

The current plan put forward by SecTreas Paulson is to give the Treasury the financially unlimited authority to buy the bad stuff the companies hold and to socialize their losses. The CBO letter is the typical economic ‘on one hand…, on the other hand…’ answer one would expect. But it then uses some curious probablilities to in the end come up with only one number:

The Congressional Budget Office (CBO) estimates that there is a significant chance—probably better than 50 percent—that the proposed new Treasury authority would not be used before it expired at the end of December 2009. […] Under that scenario, the temporary authority would not be used and thus would involve no budgetary cost.

[…]
In CBO’s view, however, that scenario is far from the only possible result. […] Taking into account the probability of various possible outcomes, CBO estimates that the expected value of the federal budgetary cost from enacting this proposal would be $25 billion over fiscal years 2009 and 2010. That estimate accounts for both the possibility that federal funds would not have to be expended under the new authority and the possibility that the government would have to use that authority to provide assistance to the GSEs.

The $25 billion will be presented in the MSM as the total bailout cost for the mess. Indeed Bloomberg currently runs the headline Fannie, Freddie Rescue May Cost $25 Billion, CBO Says.

That headline is totally wrong. Those are not the costs. The $25 billion is some calculation of, for example, a 50% probability of zero loss, a 45% probability of $10 billion loss and a 5% probability of $300 billion loss for the taxpayer. The CBO notes that the possible upside from that ‘bet’ is zero.

One wonders how the CBO reached these or similar probabilities. Is the chance that no intervention is needed really 50%? Why then is Paulson proposing this at all? Is the chance of the big bang loss really only 5%? And why does the possible loss estimate stop in 2010? If the Treasury buys dubious assets from these companies could losses on these assets not occur later than 2010?

The attachment to the letter does not provide much answers to these questions. But it has some interesting numbers. The ‘Fair value’ of the three companies at the end of March was just $7 billion. Fair value is market value of all assets minus the market value of all debt. But the companies have liabilities and dubious assets in the trillions. They have

a book of business with a value of about $5.2 trillion. The riskiest loans, known as alt-A and subprime mortgages, accounted for about 15 percent of that portfolio.

Those are $780 billion of dubious Alt-A and subprime ‘assets’ that may have a real value of 80%, 60% or 40% of their nominal face value. That is the stuff the Treasury would likely buy for their nominal price. The difference to their real value would be payed by the taxpayers.

So while the top number of the CBO letter sounds like $25 billion and is headlining the MSM reports, the possible, and in my view likely, losses the U.S. taxpayer would have to carry under the Paulson plan, might well be in the hundreds of billions.

Are there better solutions than the Paulson plan? Yes, of course there are.

The Paulson plan has no possible upside for the taxpayer only downside risk. It also does not take any money away from the private shareholders of these bankrupt companies. Indeed the value of their shares would soar when the taxpayers take over the risk of these companies’ bad assets. Instead the share holdings should be wiped out and the companies outright nationalized. The owners of Fannie and Freddy debt should also take a haircut. Fannie and Freddy debt always payed higher interest than treasury notes. If the U.S. government takes over these companies, their debt will be as secure as treasuries and should pay the same interest rate.

The CBO letter is just a cover so that Paulson, Schumer, Frank and their like screw the taxpayer with the losses of these companies while protecting their shareholders. That is free market capitalism in its purest form.