Accounting for Scott Sumner
This whole post is after the jump as my accounting is not ready for prime time.
Scott Sumner thinks he is the first to note that the cost to the US government of bailing out the big banks is more likely to be a profit than a cost. Clearly he doesn’t read angry bear much, as I have been predicting that for months.
His accounting strikes me as very odd. Last I hear, the total cost of bailouts (including GSEs, AIG, GM and Chrysler) was predicted to be $87 billion. This does not include the cost of the FDIC honoring its contracts which was not discretionary and not a bailout by any normal use of the word.
Now Sumner reports the good news that the cost not including GM and Chrysler will be only 158 billion ?!?
Huh what happened ? First I think he forgot about roughly 125 billion when he wrote “Last time I wrote on this subject the eventual cost to the government from bailing out the big banks was estimated at a negative $7 billion–in other words a profit to Uncle Sam of $7 billion.” I believe that when he wrote “the government” and “uncle Sam” he meant “The Treasury”. Uncle Sam also has this little organization called the Federal Reserve Board. Last I heard it was predicted to make a profit of 125 billion out of its bailout efforts. Not all of that involved big banks, but I just don’t believe that the government made only 7 billion out of its direct interactions with big banks. In any case, the 125 billion (or probably more now) seems to have escaped Prof. Sumner’s notice entirely.
The news which he reports is that the current guess is that the cost of bailing out AIG is going to be about zero. That is, the amount AIG owes is roughly equal to the expected present value of future repayments.
Sumner gets his huge loss overall because he describes the cost of bailing out Fannie and Freddie as “$165 billion and rising.” I believe this is the amount they owe the Treasury minus zero. Sumner argues that big banks and AIG were OK investments and GSEs weren’t because in one case he includes expected discounted repayments and in the other he decides they are zero.
It is worth noting that the GSE rescue involved loans at 10% per year and the GSE debt is not equal to money transferred from the Treasury to GSEs plus the interest the Treasury paid on that extra debt. Oh no. It is the amount transfered plus penalty interest rates charged on that amount.
Basically, I beleive that Sumner did not stick to a consistent definition of “cost” and redefines the word so as to generate meaningless numbers which confirm his prejudices.
Also he doens’t understand the extent of the US government and thinks it is just the department of the Treasury.
One of us is profoundly confused.
And hey, I’m not up on the details, but didn’t our high-end civil servants tell us along the way that all was well with our “investment”? I’m glad we have bloggers who keep track of these things, but didn’t we get the skinny from Treasury and the Fed and the TARP execs along the way?
Last I heard, the FDIC was about out of funds collected as insurance, so to keep on closing banks the depositor friendly way they will need help from the treasury.
Even so I don’t think we want to go back to the pre 1940s were banks just put up an out of business sign and then zero out our checking and savings accounts, leave us with a pile of CDs, and call it even. We just found out how nasty things can be when we get “wholesale” bank runs, and bringing back the retail bank run would be a step in the wrong direction.
s_t_r is correct, of course: there are no conventional accounting rules to sort this out. Just using the term, “cost” (an economic term) instead of “expense” (an accounting term) indicates a degree of confusion.
The economic cost of the bank bailout is deflation and 10% unemployment and a lost decade of growth — a deadweight loss that runs into the trillions.
But, generally, I think those doing an accounting are interested, not in economic costs, in terms of opportunities to use real resources foregone, but, rather, transfers, in the form of both direct payments and the assumption of risk, without adequate compensation.
There are potentially profound questions associated with the question of whether the Fed’s “investment” in AIG returns enough in cash payments to compensate for the risks assumed. Technically, I suppose, there might be a positive difference in cash out and cash back, without the Fed “making a profit” by any reasonable standard.
The FDIC’s receivership of failing banks is financed, in theory, not by Congressional appropriation, but by an insurance fund, financed, in turn, by premiums paid by banks. The FDIC fund, is, of course, exhausted, and we are only assuming that the banks will actually pay in the future, enough to make up the difference. Again, even if nominal out today is overtopped by nominal in, some day real soon, we could still question whether there’s a “profit”.
The receivership of Fannie and Freddie is a different case, and I think Scott Sumner is on solid ground. Those institutions had very little capital to begin with, and it is gone. In theory, Fannie and Freddie have recourse to the original underwriters of bad mortgages or bad securities, but that’s only theory, since many of the worst of the worst have been liquidated or are bankrupt. The Treasury is making the banks whole, with no expectation of recovering any of the money, and the magnitudes simply overwhelm the net on TARP. This is the redemption of toxic assets, and the net expense can only be “minimized” by having those institutions sponsor brutal campaigns of foreclosure against former home “owners”. However, you account the expense, on balance, the cost to the nation’s integrity and middle class is staggering.
I agree. wasn’t proposing a return to those dear old unregulated days. but maybe a raise in the insurance premium to reflect the true level of risk?
The FDIC has been proposing that, under protest from the banks of course. Haven’t heard lately how that’s going.
It ain’t over yet either, and we don’t even know what inning we are in. Summer didn’t seem concerned about the “securities” the Fed is holding in Maiden Lane either. But it’s been like pulling Ben’s teeth to get him to tell us what he’s bought.
F&F just announced they are going to get tough on forclosures. Maybe the ball game is just getting started there?
The only one that I’ve heard say the taxpayer is making money off this was Larry “Green Shoots” Kudlow when GS paid back TARP early, with interest tho a much worse deal than Buffet negotiated, to “get the govmint of their backs”, and pay themselves a bizillion in bonuses in good conscience.
But maybe I missed something. Maybe the GM IPO is expected to be a resounding success? Something good happening at Citi or BA??????? Did we get money for Chrysler or just the pension liability?
It is one thing to make up rules as one goes along. It is another to make up different rules for different lines in the same blog post.
I don’t claim that Sumners accounting for AIG is definitely wrong, nor do I assert that his accounting for the GSEs is definitely wrong, but I do assert that they can’t both be right.
He didn’t make up a rule. He didn’t follow a rule at all. Rather he said that anything with “government” in the acronym is bad and anything without “government” in the name is good (or mabye anyting started by FDR is bad and anything started by a super rich book cooker is good).
Oh yes pretty good happened at Citi. The Treasury sold some of its shares for a large profit as they have roughly doubled in value since the Treasury converted preferred shares to common stock.
That was $ 2 billion in gross profit for 20% of its stake. Pretty good I’d say.
You describe the cost of the crisis as a cost of the bank bailout. Do you think that the Clap is a cost of Penicillin ?
To defend Sumner’s calculation for the GSEs you have to claim they will pay zero to the treasury. This is very unlikely. As I noted part of the money sent to the GSEs was in exchange for instruments which pay 10% per year. The GSEs have been making dividend payments. Some, but not all of it has been rolled over. Much of the GSE debt is *not*money transferred from the Treasury plus the interest the Treasury paid on the bonds it sold to get that money. It is those huge repayments rolled over. Loan sharks typically write off assets when their clients die. That doesn’t mean they are charities.
In April the expected loss was officially estimated at $85 billion http://tinyurl.com/29w324c. That is roughly half of total money sent GSE way. How did it go from roughly half to roughly all (I suspect exactly all) ? I note again that further discretionary transfers from the Treasury to the GSEs (which have occured) do *not* necessarily mean increased losses. The GSEs are paying dividends to the Treasury (some of which are rolled over that is returned as new loans).
I agree with you thta it is important and difficult to account for the risk born by the Treasury. However, I think this is a good thing so that if the Treasury makes a riskless profit that is good and if it makes a risky profit that is better. The Treasury bearing risk means there is a huge deficit if things turn out worse than expected. That is an automatic stabilizer which is a good thing.
Now given this logic I should argue that the Treasury should always go long risky assets and not just buy them in a crisis. I have repeatedly argued exactly that on this blog. Counterarguments include “that would be socialism” to which I replied “yes. So” and “you mean you want the social security administration to invest its trust fund in stock” to which I replied. Yes. I recall no arguments explaining why my proposal wouldn’t have an effect on welfare somewhat better than winning a trillion dollar sure thing.
Well of. You make it sound like we should have financial crisis more often. Maybe the USG can balance the budget that way.
I think the Buffet deal with GS was $5B in preferred stock. It had a hefty div, on the order of 10%. But he got cap gains too. Not as much as the common stock moved of course, but something. Tho it may be convertible too, don’t know on that point.
It’s just that I’m not sure how they are valuing any of this stuff that’s outside of a simple loan and interest. Like Maiden Lane, which there was no market for the stuff that went there.
Well, let’s not forget that it is very easy to lose money. But I guess the American Eagle is technically part of the vulture family, so maybe the gummint is the bond vulture of last resort?