Sunday, September 21, 2008

The Cost of Government Bailouts

Readers Question: When central banks "lend" such vast amounts of money as they have this week, where does this actually come from?, or are they in effect masking a confidence trick and in doing so shoring up the inevitability of depreciating currencies in future?

It comes from you the taxpayer!

When the US Government lent Insurance Giant AIG $85bn, it comes from the US treasury. In other words the taxpayer is liable. It is the same with the bail out of Freddie Mac and Fannie Mae and Northern Rock. If these firms fail and the loans are not recovered, then there will simply be an increase in the national debt - the taxpayer is liable. National debt is currently 65% of GDP in the US. This could easily increase to 85% if the government have to pay the total cost of all the bad debts it is taking responsibility for.

UK National debt is currently 40% of GDP, an increase in the national debt to 50% would not cripple the economy, but, it would be very expensive. Needless to say I doubt UK taxpayers will be happy to bail out the mistakes of millionaire bankers. This is why Gordon Brown was so keen on Lloyds TSB to take over HBOS, - it is a solution which doesn't require the exposure of more taxpayers money.

However, it is worth bearing in mind, if house prices stabilise, if home repossessions don't keep rising, if the financial system stabilises, then the government will not lose that much money. (although that is quite a lot of ifs! :) ) For example, in the 1980s, the failure of savings and loan banks in the US caused the government to intervene and buy all these bad debts. In the end, the government actually got a lot of the money back. Although they may have caused moral hazard into the process . Of course, the situation is different now, with house prices falling, the cost to the taxpayer is substantial. The main argument is that it would be much more costly without intervention

The effect of higher National Debt will be
  • Higher taxes in the future
  • Higher interest rates in the future.
  • The problem is national debt is forecast to rise anyway because of ageing populations
The remote but potential risk is that the US government could one day default on its debt. If the US government became a bad debter, that really would be the end of the world. The dollar would collapse, the financial system would collapse, and in 20 years we would probably be all speaking Chinese :)


Basudeb Sen said...

The idea that the private sector firms are "bailed out" and the money used for bail-out is "tax-payers money" are misleading ideas coined by politicians and bureacracy to fool the public and shift the blame of causing crises from the politicians' and bureaucracy's shoulders to others. The plain truth is in many instances is that the politicians/ Govts. and bureacracy plant the seeds of crises to perpetuate the popularity of the false notion that Govt. is an institution on which the people can depend on and trust for improving the common wellbeing. In the current case it was the Govts which wanted to show growth in economy and employment through forced rise in home construction by encouraging/ patronising builders, inducing banks, Fredie, Fennie and investment banks to encourage housing finance booms, allow builder promoted housing finance that could be refinaced, permit extremely high imprudent leveraging by investment banks and concentration of home-mortgage loans in portfolios without ignoring basic principles of market demand-supply dynamics and regulations required to control systemic risks. In the process the Govt. collected huge amounts of taxes (mortgage stamp duty, municipal fees, income taxes from the earnings from mortgage loans etc). The financial crises were therefore really created by the Govt and politicians and they are now bailing themselves out (the private investors in private firms have already lost their moneies) and funding the bail-out by returning the ill-gotten inflated taxes by forced income generation through artificial elongation of housing construction. So, it is not tax payers' money really - it is the the retrun of extra tax money artificially created earleir by the Govt. In any case, Govt does not get taxes from eveyone and taxes do not cover govt. expenses: govt borrows huge amounts of money from the public and foreigners (Cineses investment in treasury bills!) and simply resort to deficit financing by printing extra notes/ creating extra cas reserves for the banks..
I am aware the above is unconventional view and somewhat dramatised but it is necessary to tell the Govt.s/ politicians and traditional socialist economic analystss that they cannot continue to fool the public in the same manner for long. Such Govt. bailout of Govts at the cost of the economy will become increasingly clear to the public.

Anonymous said...

The Govt. is an institution that can run perpetual spongy schmes - raising debt from present generations and repaying the debt by raising more debt from future generations. That is what most Govts. do.

Anonymous said...

Basudeb, got long winded but is on to much of the truth. We had the dot com bubble, so the fed cut interest rates so as to not allow the economy to fully digest the stupidity of the dot com bubble. The cut in rates created a housing boom, via artifically low interest rates. Housing became cheap relative to interest rates, so prices spiked, topping out with a speculative final push upward. Then the inevitable collapse. Had the fed not cut interest rates to the extent they did in early 2000, NONE of this would have happened! Now in an attempt to prevent the natural consequences of the burst housing bubble the Goverment meddles again; thus creating the next bubble. This bubble is the currency bubble. And notice how each bubble is larger than the last. This currency bubble is the last bubble and is very likely to bring the whole house down.