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Worried About The Size of The Federal Debt? There’s Another Number That Should Really Scare You.

Fat Chance - Banks Take Responsibility for the Financial Crisis by Michael Smith via Flikr

$53 trillion.

More than THREE TIMES the entire federal debt.

According to Saturday’s New York Times, that’s the amount of money currently held by US-based “too-big-to-fail” financial institutions.

“Too-big-to-fail” has been around for a while.  It dates back to the Reagan administration’s takeover of Continental Illinois National Bank and Trust Company, which was then the seventh-largest US bank.

And it’s been a growing problem ever since.

Here’s why: “TBTF” distorts the economy.  In theory, in a capitalist economy, there should be a relationship between risk and reward.  In theory, people who can’t afford to lose their money will chose “safe” investments, even though they have a lower rate of return; and even those people who can afford to lose money will take fewer risks.

But that’s only in theory.  In reality, TBTF has separated “risk” from “reward”.  The financial industry is now operating on the belief that if the loss is big enough, the government will step in.

It’s sort of like insurance… only, the financial industry doesn’t have to pay for it.

A year and a half ago, one Federal Reserve Bank economist estimated the TBTF effect is worth between $450 and $900 billion a year.

“The existence of the implicit subsidy enabled these companies to become larger and more complex than otherwise would have been the case. TBTF institutions respond to the subsidy by increasing their risk through either engaging in riskier activities or increasing their leverage. While these actions may be privately optimal, the response to the TBTF subsidy is not socially optimal, as it can pose huge risks to the financial system.”

(Gotta love that economist-speak…“Not socially optimal,” indeed.)

Even since the 2007 Wall Street meltdown, financial institutions have continued to take advantage of their TBTF status.  TBTF institutions are still getting bigger and taking more risks.  Here’s how Forbes described the situation last year:  “Banks today are bigger and more opaque than ever, and they continue to trade in derivatives in many of the same ways they did before the crash, but on a larger scale and with precisely the same unknown risks.”

And now, a half-decade after the bailout, the TBTF institutions are worth $53 trillion.

So why am I comparing the size of the financial industry with the size of the federal debt?

I was trying to figure out the current level of taxpayer exposure, in this “not socially optimal” arrangement.  In other words: if the financial industry implodes again, how much government money is it going to cost us?  And I figured the best way to figure that out was to look at what happened in the most-recent TBTF bailout.

As near as I could figure, from what’s easily available on the Internet: back before the 2007 meltdown, TBTF institutions were worth a total of about $2 trillion.  The 2008 bailout bill appropriated $700 billion to deal with the crisis — or, roughly one-third of the total value of TBTF institutions, before they started to fail.

The federal budget was already running a deficit.  That means: in order to fund the bailout, Congress had to borrow an amount equal to one-third of the pre-crisis value of those TBTF institutions (using my “as near as I can figure” estimate).

But those TBTF institutions are bigger now; and that means if they fail, any federal government bailout would need to be bigger, too.

TBTF are now worth $53 trillion. Do the math.  If there is another Wall Street meltdown; and another bailout; and this next bailout also requires the government to borrow an amount equal to one-third of what TBTF institutions are worth now…

Well…one-third of $53 trillion is…almost exactly the current amount of the federal debt.

In other words, the next financial meltdown could double the national debt.

Are you scared yet?

America’s economy: socialized risks, privatized profits?!!?

Edgar Degas - The Orchestra at the Opera - Google Art Project 2Orchestrated?!!? Why would anybody think the public messaging was orchestrated?

Just because yesterday – Sunday – a group of hedge fund investors sued the US Treasury over dividends they want to get from mortgage-guarantee firms Fannie Mae and Freddie Mac. (And of course, since it was Sunday, there were no Treasury representatives immediately available to respond to the lawsuit. Which means the public is hearing only the investors’ side of the story, in all those thousands of stories about the lawsuit now running nationwide.)

And in today’s Boston Globe, there is a column by former NH Senator John E. Sununu arguing that Fannie Mae and Freddie Mac should be “retooled” – before the companies have the opportunity to “pay back the funds taxpayers sank into them” at the beginning of the Great Recession. (In case you’ve forgotten, we the taxpayers spent about $188 billion to bailout the two mortgage giants.)

The plan Sununu is endorsing wouldn’t actually eliminate government guarantees for the “retooled” and “reformed” new “Federal Mortgage Insurance Corporation”. No, no… the corporation would still have taxpayers as a financial backstop. But somehow, through the magic of federal legislation, “private financiers should have incentives to manage risk more effectively than in the past.”

Sunday court filings? Monday newspaper columns? Why on earth would anybody think there might possibly be a deliberate messaging campaign here?

Here’s MY short version of what’s at stake:

In the past several months, hedge funds have been quietly buying up shares in Fannie and Freddie. Those shares used to be basically worthless…. but their value is rising even as I type this post.

And for the past couple of months, hedge fund lobbyists have been quietly meeting with Congressional leaders to push “reform” efforts similar to the plan Sununu endorsed in the Globe today. Under current law, “Treasury holds $188.5 billion in senior preferred shares in the two companies, representing the amount of aid they have drawn from taxpayers to stay afloat. [As of April,] The companies have sent back $65.2 billion in dividends, which count as a return on the government’s investment and not as a repayment. Treasury also holds warrants to purchase nearly 80 percent of the companies’ outstanding common stock. “ But now that Fannie and Freddie are turning a profit, hedge fund lobbyists want to return the companies to private ownership.

That’s what’s at stake: billions of dollars in profits.

In all the stories I’ve read today, nobody is suggesting the private sector should assume all the risk inherent in the mortgage market. No, it seems they’re happy to have the federal government – we, the taxpayers – as the ultimate guarantor. In other words, the risk is “socialized”.

They just want the profits to be privatized.

And the way they phrase it, it all sounds so reasonable… if you’re too hot and tired to think twice about it… or if you’re relaxed and in a good mood from a July 4th vacation. And besides, the story broke on Sunday, with nobody around to give the other side.

As a professional communicator, myself, I gotta admire their timing and technique.

But as a member of the 99%, I am appalled at their insistence that profits should belong to hedge fund investors, rather than to the taxpayers who will continue to bear the investment risk.

—–

Read “How do we get an economy that works for the 99%?” here.

Quote of the week:

“We must make our choice. We may have democracy, or we may have wealth concentrated in the hands of a few, but we can’t have both.” – Supreme Court Justice Louis Brandeis

 

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