Thursday, May 13, 2010

Update: “Bail-Out” City

From the Desk of Joe Rollins

In September of 2008, I wrote a post entitled, “This is NOT a Bailout!!” At that time, the proposed plan to save the U.S. financial system was only three pages, and in my post I stated that it was more of a money-making venture than we were being led to believe by the financial press. After all, if you invest in assets, eventually those assets will provide a return.

As we all know, the Troubled Asset Relief Program (“TARP”) became something completely different than what was originally proposed back in September of 2008. When it was thought that purchasing troubled assets from the banks was going to take too long and be too political, it was decided that direct investments into the major U.S. banks would be a quicker and more efficient way to complete the task. At that time, many editorialized that it was ridiculous for the federal government to be investing in the U.S. banks. In fact, many of the famous economists writing for the New York Times forecasted that all major U.S. banks would have to be nationalized in order to ever repay these investments. Boy, were they wrong!

I argued in 2008 that the TARP had nothing to do with a bailout; rather, it had to do with stabilizing the economy and improving the financial stability of the U.S. markets. Approximately two years later, we now know that the “bailout” has been far less expensive than what was originally anticipated. It was forecasted last month that the TARP will have a projected loss of less than $89 billion, far less than earlier forecasts. Less than one year ago, the Congressional Budget Office and the Office of Management and Budget estimated that the bailout cost would be approximately $250 billion.

Last month Secretary of the Treasury Timothy Geithner forecasted that the TARP investment loss would be no greater than 1% of GDP, approximately $140 billion. What’s so amazing about this percentage is that many government officials were forecasting losses on the TARP to be many times the cost of bailing out the savings and loan industries in the late 1980’s and early 1990’s. The total loss in those years was 3.2% of GDP as compared to the loss from the TARP likely being less than 1% of GDP.

These projected losses are even more impressive when you consider that the TARP includes some investments that were clearly ill-advised. You may recall that at the end of the period, the federal government invested money in General Motors and Chrysler Corporation. Saving these companies was never a consideration when the TARP was originally designed. In my opinion, these investments were granted only to repay political favors; they had nothing to do with financial stabilization of the banking industry.

The government has also invested over $145 billion in Fannie Mae and Freddie Mac. These two quasi-government agencies are just a black hole for losing money! While it is amazing that the U.S. congress has been discussing and debating financial reform for the banking industry and Wall Street for several months, not once has the reform of Fannie Mae and Freddie Mac ever been discussed. As recently as last month, the government waived all caps of financial aid to these troubled governmental agencies, which means they essentially have a blank check to continue losing money.

Fannie and Freddie’s extraordinary ineptitude is truly fascinating. For the first quarter of 2010, Fannie reported a cool loss of $13 billion; Freddie was not far behind, losing $10.6 billion. Comparatively, for the first quarter of 2010, all of the banks and Wall Street firms that the government is trying to regulate reported sky-high profits. Isn’t it ironic that the government is trying to regulate businesses that are profitable and well-managed when it refuses to even consider regulating the two companies that were probably the source of the financial downturn in the first place?

Fannie has already borrowed $75 billion and made a new request for $8.4 billion in additional government financing from the taxpayers. Freddie previously borrowed over $50 billion and is now seeking another $10.6 billion in financing. These guys just can’t seem to lose enough taxpayer money! Obviously, these organizations continue to lose money because they’re essentially an arm of congress that uses taxpayer money to subsidize congress’s pet projects regardless of whether or not they make economic sense.

Yesterday, the senate had an opportunity to sever its financial ties to Fannie Mae and Freddie Mac. There was a bill before the senate that would have given Freddie and Fannie two years to wind down and sell off their loan portfolios. In other words, the bill proposed that the government get out of the mortgage business entirely and turn over mortgage lending back to where it belongs – the local banks. Unfortunately, the senate rejected the proposal 43 to 56, basically along party lines. There’s no way this congress will give up any opportunity to spend taxpayer dollars to accomplish their own political goals.

Perhaps congress and the Obama administration need to be questioned as to why Freddie and Fannie aren’t included in their financial reform proposals the next time they complain that nothing is getting passed. I remind you of Congressman Barney Frank’s famous quote from 2003, “I want to roll the dice a little bit more in this situation towards subsidized housing.” Well, Congressman Frank sure did roll the dice – all at the taxpayers’ (yours and mine) expense.

The original TARP proposal was designed to assist the banks; it was never designed to bail out car companies, and it was never designed to bail out Freddie and Fannie. The original three-page proposal that then Secretary of the Treasury Hank Paulson proposed to congress was to stabilize the banking industry and get lending started again in America.

Nonetheless, less than two years later, we now know the result of the TARP. According to The Wall Street Journal, of the original $245 billion that the Treasury invested in the U.S. banks, $169 billion has already been returned to the Treasury. Furthermore, the U.S. government has collected approximately $13.7 billion in dividends, interest and other income, along with $4 billion that they earned in selling warrants they received with the original loans.

The Treasury now forecasts that of the amount of money invested in the U.S. banks, the TARP will actually have an estimated eventual profit of $8 billion. Yes, after two years, I can finally say that my September, 2008 blog was correct – the TARP was NOT a bailout, it was a well-conceived program wherein the U.S. government made money on their short-term investment in order to stabilize the banking industry in America.

Of the three major investments left, it is highly likely that American International Group (“AIG”) will be able to repay 100% of its loan to the Treasury within one year. This is a major accomplishment given that at one point, loans to AIG exceeded $100 billion.

There is also a 50/50 chance that General Motors will repay their loan to the government once an IPO is completed on the sale of their stock. While there was a lot of publicity this month when GM agreed to repay their loan to the Treasury of $6.7 billion, there was almost no publicity that those funds were actually repaid with money that had been kept in an escrow account by the government and had never actually been loaned to GM in the first place. However, there continues to be approximately $35 billion invested in the common stock of GM that can only be cashed out when the government sells its stock in the open market to other investors.

It’s also true that the Treasury invested $32 billion in the common stock of Citigroup, Inc. While there was great outrage among the public at the time regarding this investment, as of today that investment is worth approximately $6 billion more than the amount invested by the government.

The only investment that appears to be a sure loser is Chrysler Corporation. Of course, we should never expect to receive the money from Freddie and Fannie; they continue to be a complete embarrassment to the government since they cannot control the losses and they cannot keep the politics out of those operations.

The end result of the TARP is that it has been almost overwhelmingly successful and very useful in calming the financial markets during a very troubling time. Had we been able to keep the politicians from making the investments in GM, Chrysler, Freddie and Fannie, it is highly likely that the U.S. government would have made a major profit on the original TARP. In Washington, it seems that politics always controls financial decisions – usually to the detriment of the taxpayers.

Almost every week I am asked to comment on the “bailout.” My comment remains that it wasn’t a bailout of the banks; rather, it was a bailout for the taxpayers. Be sure to let me know if you ever read about the success of the TARP anywhere other than here.

As always, the foregoing comments are my opinions, thoughts and personal biases. In all cases, I could be wrong.