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