July 21st, 2011

What did the big bank bailout really cost us?

by Peter Miller


Treasury Dollar BillThe big bank bailout is largely over and done–we hope–and now comes the conclusion that it was a success.

Financial columnists Alan Sloan and Doris Burke write in the Washington Post that:

The bailout, by the numbers, clearly did work. Not only did it forestall a worldwide financial meltdown, but a Fortune analysis shows that U.S. taxpayers are also coming out ahead on it–by at least $40 billion, and possibly by as much as $100 billion eventually.

Sloan and Burke explain that a big part of the bailout profits for Uncle Sam come from newly-minted Federal Reserve revenues that have been turned over to the Treasury–about $100 billion so far and perhaps another $85 billion this year and next. Such revenues offset and exceed program costs and losses by this accounting.

This is a great analysis in the sense of math, but I believe sorely misses the point.

To understand why, just look at Fannie Mae and Freddie Mac:

The biggest expense by far comes from the rescue of mortgage finance giants Fannie Mae and Freddie Mac. Or, actually, the rescue of their debtholders–stockholders have been essentially wiped out.

What rescue?

First of all, I want to know, “What rescue?”

This was the nationalization of two viable businesses. The secondary market where mortgages are bought and sold never shut down. Mortgage rates did not soar because of trouble with the two companies. Amortization schedules did not change. Mortgage rate forecasts suggesting a rise were wrong.

In other words, the government picked winners and losers.

As an alternative, Fannie Mae and Freddie Mac could have done what big companies with assets do and made good on their debts. In the worst possible case they owed several hundred billion dollars, but between them they also had $1.5 trillion in investment assets as well as an immense ability to borrow.

It would have been painful and ugly, but the companies would likely have survived.

Banks lost money

Now let’s talk about those mysterious stockholders who lost just about everything.

Among the shareholders were a large number of banks. Why? Because government regulators told bankers that they could maintain capital reserves by holding preferred stock in supposedly super-safe Fannie Mae and Freddie Mac.

According to the American Bankers Association, the nation’s largest banks stood likely to lose between $10 and $15 billion as a result of the takeover of Fannie Mae and Freddie Mac. That’s a livable loss (the nation’s biggest banks have trillions of dollars in assets).

Small banks lost big time

But for the nation’s community banks, the situation was not so easy (they have far less capital). The Independent Community Bankers of America estimated that small local banks lost $16 billion from the nationalization of Fannie Mae and Freddie Mac.

That missing capital had to be made up with new cash otherwise the impacted small banks were instantly in the position of lending more than their capital base allowed. That means they were out of business.

Here’s what happened:

1.  There were no bank failures in 2005 and 2006

2.  There were three bank failures in 2007

3.  There were 25 bank failures in 2008

4.  There were 140 bank failures in 2009

5.  There were 157 bank failures in 2010

6.  As of July 15th, there were 55 bank failures in 2011

The bailout was unsuccessful for many

To say that the government bailout has been a “success” depends very much on how one defines the term. The bailout certainly wasn’t a success for:

The lenders who followed government directives and bought shares in Fannie Mae and Freddie Mac

The pensions, insurance companies and investors who bought into the companies

The banks that made no toxic loans

The people who worked for good lenders and lost their jobs

Today, Fannie Mae shares sell for about 34 cents. In 2008, the high price was $40.69 per share. Given 1.12 billion shares, the loss to shareholders has been greater than $45 billion.

As to Freddie Mac, it sold for $32.74 a share as of January 2, 2008. By the end of the year the stock was worth 73 cents per share. With 1.16 billion shares, it means that investors lost more than $37 billion.

Now, repeat this exercise with the hundreds of banks that went out of business because their capital was suddenly nonexistent and with the big banks that lost billions.

If the argument is that the 2007 bailout was good because it prevented a depression, then perhaps yes. If the argument is that the 2007 bailout was good because it somehow produced a profit for the government, then please explain what it has cost the rest of us.

Share and Enjoy:
  • email
  • Print
  • RSS
  • Add to favorites
  • Yahoo! Bookmarks
  • Facebook
  • Twitter
  • Technorati
  • Digg
  • del.icio.us
  • Google Bookmarks
  • StumbleUpon
  • Yahoo! Buzz
  • Mixx
  • BlinkList
  • Live
  • Reddit

Leave a Comment

Receive Updates via Email

Delivered by FeedBurner

About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

Our bloggers:

Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

Connect With Us

  • rss feed icon
  • facebook icon
  • twitter icon

Compare Lowest Mortgage Rates