Moon of Alabama Brecht quote
July 22, 2008

Fannie Freddie Bailout Cover

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.

Posted by b on July 22, 2008 at 18:43 UTC | Permalink


Economic Blues

Housing and securities prices are going down; food and fuel prices are rising. How will these opposite trends affect our economy looking ahead?

The real estate bubble (US capitalism's latest toxic mix of profit-driven over-investment, over-lending, and financial fraud) is in full "bust" mode. Residential and now also commercial real estate prices are dropping quickly. Millions of families who used their rising home prices over the last decade to borrow money (the "refinancing" boom) can no longer do so. Their consumption thereupon falls as do the fortunes of all the producers who depend on that consumption. As other home "owners" default by the millions on unsustainable mortgages, foreclosures throw ever more houses onto a market with many fewer buyers. This drives home prices down further and likewise consumption. This process is now leading world capitalism into a "global slowdown in production."

At the same time, the world of financial investing (banks, hedge funds, stock brokers, etc.) is reeling from widening real-estate losses. Investors globally bought billions of US securities based on US mortgages (and other kinds of loans) whose borrowers can not make the required repayments. First these big investors produced the real estate bubble monster and now they scramble to survive its bursting, to avoid fates like that of Bear Stearns. So they cut back credit to still other borrowers who now struggle to cope with lost borrowing capability. This too contributes to the "global slowdown." Modern capitalism is caught up in yet another Frankenstein story.

Can you say, Bale out!? Tax payers have only begun to pay...

Crisis & Response and pay they will...

Posted by: Uncle $cam | Jul 22 2008 19:33 utc | 1

This is oddly familiar to the logic of the CDO's. $25billion is the AAA rated portion of the rescue?

Posted by: YY | Jul 23 2008 0:50 utc | 2

More of your sarcasm, eh b?
b: "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."
“Free market capitalism in its purest form” is no government intervention.
Privatizing gains and socializing losses is not free market. What is the correct economic term? Corporatism comes to my mind. As usual, your valid concerns don’t appear to bother our mainstream media people.

Posted by: Rick | Jul 23 2008 3:31 utc | 3

@Rick - that sarcasm is justified because the corporatism is sold as "free markets"

Lawmakers Agree on Outline of Big Housing Pact

House and Senate leaders have largely hammered out a compromise deal on a mammoth housing package that would permit the government to bolster Fannie Mae and Freddie Mac in an emergency, overhaul supervision of the housing-finance giants and allow the government to insure up to $300 billion in refinanced mortgages.
Lawmakers plan to raise the public-debt limit as part of the legislation to $10.6 trillion from $9.8 trillion. Congress must vote to increase the limit to account for additional borrowing, something it is loath to do, although it would have had to take that step this year even without the rescue plan for Fannie and Freddie, Democratic aides said.

Posted by: b | Jul 23 2008 8:44 utc | 4

b, "Corporatism is sold as free markets"

Yeah, "sold" like so much of the rest of our "free market" junk - more like forced down our throats!

Posted by: Rick | Jul 23 2008 15:11 utc | 5

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