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The Government’s Ballooning Bailout

Published 09/19/08 Craig Harrington - Print Article
E-mail - editor@economyincisis.org

The Federal Reserve, Treasury Department and Congress are set to spend the weekend organizing the largest economic bailout in United States history, according to CNN Money.

In March the Federal Reserve fronted $29 billion to prop up Bear Stearns during its acquisition by JPMorgan Chase. Two weeks ago the Treasury dedicated up to $200 billion more to guarantee Fannie Mae and Freddie Mac. Just days ago the Federal Reserve acted again, putting $85 billion behind American International Group during the nationalization of that firm. The new spending plan will likely entail up to $500 billion in extra funding. When coupled with all of the major and minor moves of the past year, the grand total of the government’s impromptu attempts to stem the combined credit, housing and banking crisis could top $1 trillion.

During the Savings and Loan Crisis of the late 1980s and early 1990s the Treasury Department Created the Resolution Trust Corporation. The RTC was subsumed by the FDIC after the crisis was over, but during its run it acquired and disposed of hundreds of billions of dollars worth of bad mortgages and loans.

Essentially, the failing saving and loan institutions were allowed to give their indebted assets to the government and the government agreed to cover those assets with taxpayer money. If the Resolution Trust Corporation is reincorporated by the government it would likely take on a much larger sum of similar debt, this time obtaining toxic subprime loans from commercial banks.

The purpose of such a government mechanism is somewhat counterintuitive. It agrees to take on debt at great cost, knowing that it will not recover any value for them. The government takes the bad debt out of the economy, like a surgeon removing a cancer, and allows the commercial enterprise to regain its strength.

It is unclear what ramifications this proposed move would have for taxpayers. They would not be directly affected; no taxes would be increased to finance the move, and the money used to pay for the program is already held by the Treasury. On the other hand, the program would drastically decrease the amount of money held by the government (the hundreds of billions used to cover toxic debt would literally be blanked out), and this could alter long-term policy decisions regarding future spending and tax policies.

Source CNN Money:

The federal government, in what will be its most far-reaching attempt yet to contain the financial crisis, is poised to establish a program to let banks get rid of mortgage-related assets that have been hard to value and harder to trade.

Treasury Secretary Henry Paulson announced the framework of the plan on Friday morning. "The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy," said Paulson.

…

On Friday morning, Sen. Richard Shelby, R-Ala., who is the ranking member on the Senate Banking Committee, told CNN that the latest plan from Treasury could cost $500 billion. If so, combined with all the other monies committed by the Federal Reserve and Treasury in the form of loans and investments, that brings the headline figure on their attempts to stem the credit crisis to $1.3 trillion.

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