Now We Must Ask, ‘But What Is It Going to Cost?’

Posted October 6, 2008 at 5:06pm

The “it” in the headline above is the Paulson plan, the Paulson-Frank-Dodd plan, the Troubled Asset Relief Plan, the Wall Street bailout, the credit market rescue or anything else you want to call the legislation enacted last week.

[IMGCAP(1)]The need to fix credit markets rather than the cost of this new law was the focus of the debate. But now that the debate is over and the legislation has been signed, it’s not just appropriate but necessary to ask the question of what this is going to cost.

The $700 billion in TARP will be provided in stages and approvals are needed to spend it all, so the actual amount spent could be much less than the big number.

But it’s also possible that the amount in the bill won’t be enough to deal with the problem. I have yet to see any meaningful explanation of how this number was derived. Because it was put together so quickly and we don’t know which assets will be bought at what price, the $700 billion estimate seems to have been based more on its public relations value than on analytical rigor.

Because it could be higher or lower, let’s assume that $700 billion is what will actually be spent. And because we’re told this is needed to deal with a crisis, let’s also assume that it will all be spent by the end of the current fiscal year. (For those of you who don’t keep track of such things, fiscal 2009 began Wednesday, so there’s plenty of time to get it done in one year.)

The Congressional Budget Office and the Office of Management and Budget have both concluded that, because it involves assets purchased that will eventually be sold, the program should be scored using the relatively arcane (trust me on this) credit reform rules of the federal budget process. That means the immediate budget impact will be less than $700 billion even if it is all spent. But we don’t yet know what that number will be because it’s not at all clear what the government will pay or what it will eventually receive if and when the assets are sold. As CBO Director Peter Orszag said Wednesday in a letter to Senate Banking, Housing and Urban Affairs Chairman Chris Dodd (D-Conn.), the net cost could be anywhere from $0 to $700 billion.

Because of this, even though many analysts and commentators said last week that it would happen, at best it’s wishful thinking to assume that the federal government will break even, let alone actually make money on TARP. It could happen. But now that the law has been enacted, there is likely to be some very strong pressure on the federal government to overpay for the assets it buys and underprice them when they are sold.

In other words, although TARP proponents repeatedly talked in purely financial terms about the assets the government will be buying and selling, political considerations are also very likely to play a big role in what the government spends and recoups from these transactions.

Therefore, rather than the government breaking even or making money, it’s likely that there will end up being a substantial government subsidy. Not only might the market not be good for Washington, but there will be a great deal of pressure on the Treasury to buy above and sell below market prices.

That means TARP has probably made the federal budget outlook significantly worse.

This should not be a shock to anyone. TARP was not an investment decision by the federal government to buy currently low-priced assets so that it would earn a respectable return; it was a public policy decision to fix credit markets that were not functioning properly. The possibility of the government earning money on the deal was obviously enticing and likely swayed some votes. But the far more realistic outlook was always that this would be a cost the government had to incur because of a threat to the economy.

It also shouldn’t be that much of a surprise because past federal efforts like this have almost always involved federal costs rather than profits. The savings and loan bailout ended up costing the government more than $100 billion. The passenger railroad bailout in the early 1970s, which was supposed to result in profits from the federal operation of Amtrak, has cost billions.

Because of TARP, my estimate is that the budget deficit could easily reach or exceed $1 trillion this year. This includes my estimate of a $600 billion deficit before TARP and an additional $400 billion afterward. A deficit of that size would be 6 percent to 7 percent of gross domestic product, a level that hasn’t been reached since fiscal years 1942 to 1946 when the United States was fighting and paying for the direct costs of World War II.

But the bigger cost of TARP may well be less in dollar terms than it is in making progress in other areas. A $1 trillion, 7-percent-of-GDP deficit likely will chill most of the spending and taxing plans of whoever is elected as hoped-for tax cuts and spending increases have to be delayed. There could even be a big push for deficit reductions if the market reacts very negatively to the one-year, 10 percent increase in the national debt and interest rates are pushed higher by the bond market vigilantes that were so evident at the start of the Clinton administration.

We’ll know more about the actual costs of what was enacted last week as it’s implemented in the next few months. Given the magnitude of what’s involved, this is something that has to be monitored very closely.

Stan Collender is managing director at Qorvis Communications and author of “The Guide to the Federal Budget.” His blog is Capital Gains and Games.