In September and October 2008, the US government claimed that unless taxpayer money was pumped into the financial system, there would be chaos. At the time, it was estimated that the US taxpayer could end up losing as much as $350bn.
Three and a half years later things look very different. The latest US Treasury estimates argue that the ‘Troubled Asset Relief Program’ (Tarp) may only cost $68bn. Indeed, if aid to homeowners is excluded, Tarp’s costs fall to $22bn.
The US has also said that that it will sell $6bn of shares in the insurer AIG at $29 a share. It claims that if it manages to sell all the shares at this price, it would erase all losses from the bail-out of the insurer.
And last month, no less a figure than Clint Eastwood was touting General Motors’ turnaround.
So were the bail-outs were a success?
We can’t say for sure yet. But we do know that these figures are a complete sham. Here’s why.
1. Tax breaks
The first way in which the US government has fudged the figures is through the use of tax breaks. Normally, when company goes bankrupt, or is taken over, it loses the ability to offset past losses against tax. However, the US government waived this for General Motors and Citigroup, both of which received Tarp money. AIG got a similar deal. This means that the revenue (and share price) of these companies was boosted at the expense of US taxpayers.
The sums involved are huge. GM’s tax break could be worth up to $45bn. AIG made $17.7bn from the same tax dodge in the last quarter alone. Experts think the company is unlikely to pay any tax at all before the end of the decade.
2. Subsidies
Another trick to hide the true cost of the bail-out has been to give firms extra support to boost their profits, but not to count this as part of the overall cost to taxpayers.
Since 2009, anyone buying an electric car has received a large tax credit. Although this was available to all models, GM’s dominance of the market meant that it got most of the benefits.
The banks also benefited from other government help. As the Wall Street Journal has pointed out, they were allowed to divert $4bn of aid for small firms towards Tarp repayment. Homeowner subsides also helped the banks by increasing the number of mortgages that were repaid.
The biggest subsidy of all for the banks has come from the Federal Reserve. Indeed, the first round of quantitative easing (QE) in the US in 2009-10 focused solely on pushing up the prices of mortgages. This enabled banks to cut their losses.
This money printing may have indirectly cut the cost of Tarp. However, it also pushed up commodity prices rather than boosting demand in the wider economy, driving up costs for taxpayers.
3. The discount rate
Another problem with the official calculations is the discount rate they have used. On average, the riskier an investment is, the greater the return investors expect in the long run. Since 1900, global stock markets have returned 5.2% a year, while short-term government debt just made 1%.
Much of the money spent under Tarp involved capital injections – in other words, buying equity. However, all the revenues received from sales of bank shares in the reports are discounted at the cost of government debt, not equity.
Given that many of the biggest investments took place at the bottom of the market in 2009, the returns made should have been even higher. Any fund manager who only broke even during a period in which the market nearly doubled would be at risk of being fired.
It’s too early to say just how much the bail-outs have cost
Of the $650bn spent on Tarp, Fannie and Freddie, and AIG, less than $300bn has been returned. It’s clear that the US government is using creative accounting when it argues that Tarp will come close to making its money back.
Using measures that are more recognisable as genuine accounting, the tangible costs of Tarp and AIG will be over $100bn. There are also intangible costs. Tarp and the other bail-outs reinforced the idea that banks above a certain size will be bailed out as a matter of course.
This is not how the market is supposed to work. Bad firms should go out of business, with their investors taking losses. Anything else reduces discipline. The American Enterprise Institute claims that since the crisis, ‘too big too fail’ banks have taken more risks, while smaller firms have been more conservative.
Ironically, Lehman has just gone through its bankruptcy process, and will now be wound up. Perhaps this model should have been applied to other firms.