How much did the bailouts cost?

Deborah Lucas has studied this question, and here is the core of her results:

This review develops a theoretical framework that highlights the principles governing economically meaningful estimates of the cost of bailouts. Drawing selectively on existing cost estimates and augmenting them with new calculations consistent with this framework, I conclude that the total direct cost of the 2008 crisis-related bailouts in the United States was on the order of $500 billion, or 3.5% of GDP in 2009. The largest direct beneficiaries of the bailouts were the unsecured creditors of financial institutions. The estimated cost stands in sharp contrast to popular accounts that claim there was no cost because the money was repaid, and with claims of costs in the trillions of dollars. The cost is large enough to suggest the importance of revisiting whether there might have been less expensive ways to intervene to stabilize markets. At the same time, it is small enough to call into question whether the benefits of ending bailouts permanently exceed the regulatory burden of policies aimed at achieving that goal

Here is the paper, via the excellent Kevin Lewis.

You will note that 3/4 of that sum comes from the bailouts of the government mortgage agencies.  I am myself uncertain how to think about this problem.  First, is it useful to think of the additional bailout expenditure as being monetized, if only indirectly through the mix of Fed/Treasury policy?  If yes (debatable), and the monetization itself limits a harmful further deflation, can it be said that this monetization is not a transfer away from citizens in the usual sense that an inflation in Zimbabwe might be?  But rather a net gain for citizens or at least a much smaller loss?  Is the interest paid on those monetized reserves the actual cost?

In any case, where exactly does the “3.5% of gdp” loss “come from”?

I do not know!


That's it? $0.5T? At that price, let's inflate the next financial bubble since the US prefers this style of redistribution rather than building more homes to keep a lid on housing prices, fixing health care costs, or paying workers when they do real work. Where do we sign up for the no money down, NINJA loans to begin this whole charade? 80% of the paper shuffle in finance is make-work fake work. Farmers under Trump got almost $30 billion for growing soybeans they can't sell to China. How's that for fake work that pays real money?

More properly those bailouts should be seen as the first down payments on the unsustainable debts the various government entities have been racking up, see especially the pension disasters awaiting various Democrat states.

If the bailouts made us so much money then why don't we have another banking crisis? And then another and another until we pay off the national debt? And then keep doing it until everyone gets free college and healthcare!

A little hocus pocus and $4 trillion in bailouts never happened, erased from history. I see what you did there.

It may be that the loss comes in the form of higher interest expense for the debt of issuers that are not implicitly government backed like Fannie Mae and were not "systematically important" like AIG and Citigroup.

What debt is not backed by government?

Even the debt of workers, eg, credit card debt, payday loans, non-government student loans with 35%+, 100%+, and 10%+ interest rates are implicitly government backed by the certainty of a.TARP III, the Bush plan twice over is the only one the GOP will accept.

The GOP wants to royally screw the unsecured creditors, workers who save, small businesses with working cash, but the saner heads know making half of Trump voters homeless and hungry would not be good for the GOP.

That's why the GOP and conservatives refuse to describe the bailouts as saving the workers and their 401ks, IRAs, a million businesses payroll accounts from being frozen like Primary Reserve Fund, thanks to financial reengineering replacing FDIC accounts with wall street run money funds and stock funds.

Conservatives want debts wiped out like last when Hoover was president: workers, and businesses needing cash to operate, lose all their cash not in paper form, ie in banks or stocks/bonds.

If all the money funds had been marked to market in late 2008, the Fed could have bought $10 trillion in debt, including government bonds, for 50 cents on the dollar or less, (like Puerto Rico bonds were bought for 10%) and then forgiven lots of debtors by simple act of Congress. Instead it bought all the bonds as face value to give money funds the cash to pay depositors with no security, eg, workers and small businesses with cash savings needed to operate.

Why doesn't everyone understand the economic lesson of It's A Wonderful Life where the workers were bailed out by the workers, the common folk, putting money into the bank instead of trying to get their money out?

Ginnie Mae and FHA required bail outs? Freddie Mac and Fannie Mae were privately owned GSE, with a disclaimer along these lines - "Neither the certificates nor interest on the certificates are guaranteed by the United States, and they do not constitute a debt or obligation of the United States or any of its agencies of instrumentalities other than Fannie Mae."

Fannie and Freddie have paid $306B of dividends on Treasury's $191B investment. Where's the "cost"?

The shareholders think they deserved to get a half trillion to trillion in dividends.

The borrowers who borrowed $500,000 to buy property in 2005, that cost $150,000 in labor cost plus $100,000 in land, think they should have had been given $250,000 in cash by Congress to reduce the mortgage balance to the market price of $250,000 in 2009. Instead, the $500,000 was repaid to workers with saving from the $250,000 short sale plus $250,000 in shareholder equity confiscated by the Treasury to pay off the gse's biggest creditor, the US Treasury.

I heard her present this paper. It was very thoughtful and carefully researched. She priced government guarantees ex ante using option pricing and not ex post based on the (surprisingly low) amount actually used in the bailouts net of recoveries. It is too technical for me to get into here (and it's 3 am and I'm tired) but I believe the estimate is correct. Bob Merton also blessed her work, and he does not suffer fools.

Almost all of the "cost" calculated by the author is due to the use of fair market value accounting. She figures that the loans given to Freddie and Fannie, for example, were below market. This is a bit too theoretical for me. The government clearly did earn a profit on those loans using traditional accounting methods. If one says the the government "earned a profit" (nota bene, past tense) then ex post analysis seems appropriate. Why can't I use the same theoretical ex ante accounting on my tax return?

Another quibble is that she does not mention the additional tax revenue to the government due to these "bailouts". Had those creditors of Fannie and Freddie not been repaid, they would have had net operating losses, likely carry backs collectible immediately.

The overall macro economic costs (e.g. moral hazard) and benefits are too difficult to measure, but overall I'd say the costs and benefits of the "bailouts" remain a very open question.

Vivian, the author intended only to measure the direct cost of the bailouts. Her working definition of a bailout is (p. 87):
- A bailout involves a value transfer arising from a government subsidy or an implicit guaranty that is triggered by financial distress, or a value transfer arising from new legislation passed in response to financial distress.
- A value transfer from the government is not a bailout if a fair or market value insurance premium was assessed and collected ex-ante, or if there is a credible structure for recovering the full value of the assistance from the industry ex-post (with some caveats).

I think it's a good definition. The challenge is how to measure its direct cost, that is, the relevant value transfers that define a bailout. As she says direct costs are generally borne by taxpayers so she is measuring the fiscal cost of the bailout, not its social cost (and social benefit). Indeed the fiscal cost is a simple redistribution of income from taxpayers to the direct beneficiaries (she claims that unsecured creditors of the financial institutions got over 80% of the direct cost and borrowers from these institutions the rest).

To assess the economic costs and benefits of the bailout is still a great challenge (any reference to ongoing research I'll appreciate it). Unfortunately, the last two lines of the paper suggest that Tyler didn't read the paper and failed to realize that it was focused only on measuring the fiscal cost. In addition, Tyler’s paragraph on how the government financed this cost fails to understand that what he calls “monetized reserves” is simple intermediation of funds from depositors to government so the cost was paid by borrowing from depositors and it makes nonsense to talk about inflation.

Before the government stepped in, lots of these mortgages were heading to default. Banks and mortgage companies wanted these dodgy assets off their books. So the Fed executed a swap, accepting lots of these securities in exchange for cash, which the banks held as excess reserves earning ~0.25%, which is what banks wanted to do because in 2008 investors were also piling into cash in droves anyway, so the Fed didn't have to print new money to finance this swap, which is why we didn't get inflation.

Just by stepping in, these mortgages became more valuable (less likely to default). This is the One Weird Trick available only to central bankers, the strategy might not have worked, it was risky, but as an empirical matter, it worked, as Vivian suggests.. Earnings on the new Fed portfolio (now stabilized) outstripped the Fed's cost of borrowing (IOER to banks). As a taxpayer (i.e. one of the actual people who actually underwrote this risk), I heartily approve.

Maybe this set up a "too big to fail" regime going forward, but let's recall that lots of equity holders (Bear Stearns, Lehman Brothers, Washington Mutual) were basically wiped out, while others (e.g. Citigroup) lost 80% of value and haven't recovered.

From the Introduction to the piece:

"Some (e.g., Ball 2018) have argued that more aggressive rescue policies (e.g., of Lehman Brothers or of underwater homeowners) were clearly called for. Others (e.g., Miron 2009) believe that more institutions should have been allowed to fail, at least temporarily, so as to shift more costs to unsecured creditors."

It seems to me that there was some balance struck between letting the crisis run its course and stepping in to stave off collapse. Was it the right balance? Not sure, but lots of people got their fingers burned badly and the system didn't collapse.

All us Monday morning quarterbacks can quibble with perfect hindsight about what could have been done differently. But when the system was teetering on the verge of collapse into something far more destructive than what happened, the firemen came in and did their best in uncharted waters.

The fact is, 2008 could have been as disastrous as 1929-1933. It wasn't, and we have the bailout to thank.

+1, the bailouts were successful by any rational expectation of likely outcomes with them.

Brian, your comments are not relevant to understand and assess Deborah Lucas' research. To understand the paper, we have to look closely at her definitions, her methodology, and her data. To assess her work we have to compare it with other attempts to measure the fiscal cost of the same bailout and other bailouts.
We may regret that she limited herself to measure the direct (fiscal) cost of the bailout, but as someone that had done similar work about bailouts of banks in Latin America, I know how difficult that measurement is.
Lawrence Ball's book is important to understand the crisis, but irrelevant to Deborah's work.

OK, I read through Deborah's work. Her preferred approach, the basis for the $500 billion number, is this:

"For a bailout cost measure to be economically meaningful, it has to be evaluated as of a fixed point in time on a market or fair value basis. In most cases, the natural choice is the year the bailout is initiated, for instance, when new legislation is passed or administrative policy changes are announced or implemented, or shortly thereafter. The cost is then the net present value of associated stochastic future cash flows, evaluated using a market or fair value methodology. This is the preferred approach when it is feasible to apply it. It takes into account the full distribution of possible future cash flows to and from the government, time value, and the cost of the associated risks."

I have enough experience with stochastic modeling to understand how sensitive such models are to assumptions that are fed in. While it produces tidy and satisfying mathematical outputs, this approach suffers from a fatal flaw, as Deborah herself acknowledges:

"Properly measured, the direct costs of bailouts arising from the 2008 US financial crisis totaled approximately $500 billion. That conclusion rests on many uncertain assumptions, and the estimates presented here, individually and collectively, should be viewed as having wide error bands."

What Deborah misses here is the fact that, simply by taking action, the Fed altered the risk equation, as I mentioned above.

"What Deborah misses here is the fact that, simply by taking action, the Fed altered the risk equation, as I mentioned above."

This is sort of the issue I'm having with this, too. Her definition of "cost" doesn't seem quite right. "The cost is then the net present value of associated stochastic future cash flows, evaluated using a market or fair value methodology" That's not the cost, that's the *expected* cost at the time of the activity. If we can identify a mechanism where, by plan or accident or some combination, those "stochastic" cash flows do not materialize, then the realized cost is lower.

By analogy, if I buy shares in a company that is threatened with bankruptcy, but either I take some action that can prevent the BK or I happen to know that the likelihood of BK is well overstated, and the BK is averted and the shares climb, then I profit. The ex ante guess at what might happen is an estimate, and maybe a reasonable one for most purposes, but the reality ends up being different.

"I think it's a good definition".

I'm not so sure, especially in this case. First, how does one assess "value"? Is it "value" in the hands of the lender (the US government) or the borrowers? In this case, I assert it should be in the hands of the US government. The US government, it seems to me, does not suffer the same opportunity costs that a private lender would have had. This gets into the monetization issue. Second, it seems very difficult for me to assess (ex ante or ex post) the actual market value of what the US government gave and received in return. Yet, the author purports to know exactly what that value was.

Second, while I get that she only attempted to assess the "direct costs", why should this be the final measure of whether the bailouts were a cost or a benefit? Surely, there were other costs and benefits to the program (admittedly hard to value, but real nonetheless). Why despite the incompleteness of the "direct costs" (as she defines them) does she then (without caveats) conclude that we should explore whether there were less expensive ways to stabilize the markets?

I still have reservations about the ex ante approach. Even if I accept as fact (I don't) that the theoretical value of what the government gave was greater than what it demanded in return, and therefore that the government essentially made a bad bet, and even though they made a bad bet, it turned out they got lucky! The fact that they got lucky doesn't negate the fact that they made money!

Vivian, Deborah's two-part definition includes the essential elements of a particular type of government intervention. The first part refers to the proximate motivation for value transfers to some financially-distressed people. The second part makes clear that any value transfer to those people due to insurance premium paid ex-ante by them or to be recovered should not be counted as a bailout. It's a good start for her research but not for other purposes.

Indeed what government transfers must be of value to both the government and the financially-distressed people and each party may have different expectations over their relevant periods about the market values of what is being transferred. Past and current market values are relevant only to the extent that they inform those expectations. Thus why there are alternative methods to estimate the fiscal cost and Deborah describes them and argues in favor of the method she has chosen. Nowhere she claims to know exactly what those values are: the purpose of her research is to estimate those values. This is not a simple quid pro quo.

Yes, the government knew that it was "a bad bet", that is, that the fiscal cost was going to be positive. I hope all other bets that governments take were as easy as the one we are talking about. In most bets that governments take they don't have a clue about what the fiscal cost could be at the end of their intervention.

Yes, Deborah's research is not relevant to most issues raised by government intervention in the financial crisis. She could have concluded --using her method or any other-- that the fiscal cost was as much as 10% of GDP (perhaps the max amount pessimists thought in early 2009) or as little as 2% (the min amount that optimists expected?). Do you think Tyler's post would have been different? And the many comments to Tyler's post that are not relevant to Deborah's research?

Let me attempt to present my criticism from a somewhat different angle. Her definition of "direct costs" seems to me an attempt to sneak in indirect costs into the definition of direct costs. By using an ex ante, supposedly FMV defintion of "value", she invariably includes indirect, not to mention theoretical costs to the government.

Anyone can come up with a plausible definition of costs and benefits and apply it to these bailouts and come up with either an overall loss or an overall benefit. I don't find the work here particularly helpful and definitely not definitive.

Probably the real cost of the bail outs is the future poor economic policies that will be justified by people arguing that since banks were bailed out they should be as well. For example the 1930’s Great Depression was much worse because of the poor economic policies justified as a response to the initial slump. Arguably leading to WW2 for instance in Germany. So adapt a NGPLT policy already.

Did she include opportunity costs? Eg the costs of good bankers being stuffed and evil bankers rewarded will multi million bonuses, again?

Comparing the cost of bailouts with the cost of regulation to prevent such bailouts is like comparing the cost of going to the gym with the cost of a cardiac surgery.

I agree with Cowen: the beneficiaries of the “bailout” were owners of assets. The government and Fed stopped the deflation (falling asset prices) and then inflated (mostly financial) asset prices, the latter in large part to rebuild bank balance sheets. It worked: the owners of assets (who didn’t panic) were wealthy before the crisis and were wealthy after the crisis. Owners of highly leveraged houses, on the other hand, weren’t so fortunate, resulting in the political backlash that we continue to endure. One will recall that in the 1929 crisis the government and Fed allowed asset prices to collapse, contributing to (resulting in) the Great Depression and “correction” of wealth inequality (which remained low until the 1980s when it began the climb that reached the 1928 peak in 2008). I am confident that the formerly (before the 1929 crisis) would argue that the cost (especially to them) of the failure of a “bailout” following the 1929 crisis far exceeded the cost of the bailout following the 2008 crisis. On the other hand, our Austrian friends would argue that we have not yet experienced the day of reckoning for the 2008 “bailout”.

Whoops, I omitted “wealthy” after “(before the 1929 crisis)”

I suspect our Austrian friends are rather close to the truth. I will not stop my investments, but we started down a hill that will be enormously painful to exit.

That's all? We should have just declared a jubilee for the underwater buyers.

Money is so strange at this point. Why are we still paying taxes?

Probably because MMT gets the public one step closer to realizing our money is worthless.

Actually the fact none of the Obamacare taxes will ever be implemented along with the fact Medicare Part D was implemented without taxes means Democrats should never propose another tax increase. So any “fix” that is necessary doesn’t have to be paid for in the bill unless it is necessary to trick the CBO. That said our experience from 2009-2013 in which we essentially had universal basic income through never ending unemployment insurance benefits and expanded SNAP shows too much welfare will result in suboptimal economic growth. So Keynesian economies have a limit on welfare and that limit is that welfare that undermines the job market is counterproductive. So MMT would be counterproductive if it was used to fund a UBI program so why even bother with MMT??

If you take your greenbacks to a store, they will actually give you real stuff in exchange. Doesn't strike me as worthless.

Which is kind of what I'm getting at. If after a catastrophic drop in asset values we can just print whatever we need to tide us over until the economy catches up, then I would think we can just cap the federal budget at some percentage of GDP and have the Federal Reserve honor the government's checks. The money will enter the economy and be exchanged for real goods and services and we won't have to bother with debt and taxes.

Of course, everything I've read says that's impossible--you'll destroy your currency--so I'm happy to be proved wrong. But the same authors have been telling me that having the Fed obligingly put everything on its balance sheet will destroy the currency too, yet the currency persists in not being destroyed.

Printing money is a time-honored way of destroying a currency. Even the Romans knew this trick (tho, since they used silver coins, they literally debased the currency, so tomorrow's coins had a bit less silver than yesterday's but they did it gradually so this wasn't obvious for a while. With fiat currency, every dollar is infinitesimally debased every time a new dollar is printed.)

That's not what happened here. As 2008 progressed, everyone piled into cash, meaning banks had all these short-term liabilities against their long-term bond/mortgage portfolios (just like before the S&L crisis back in the 1980s). More worrisome than the mismatch was the specter of defaults on the asset side. Banks gladly eliminated this mismatch by selling the porfolios to the Fed. The Fed even started giving banks a bit of interests on reserves, and since the banks were paying 0% to depositors, this allowed them to eliminate their mismatch and credit risks and earn a pittance. Meanwhile, the Fed enjoyed the yield on the portfolios, which exceeded what they were paying banks in IOER. The huge swell in reserves themselves financed QE, not printing money.

I think the story is something like that. It's not MMT, it's good old fashioned Friedmanesque QTM. Sorry MMTers.

Meanwhile, the Fed enjoyed the yield on the portfolios, which exceeded what they were paying banks in IOER

Okay but wait a minute, if the portfolios were paying yields why did the Fed buy them? And what money did the Fed buy them with--cash it had carefully saved for just such an event? And how much did they buy them for: book value, FMV?

Thank you for the reply. Genuinely curious and it's well outside my bailiwick.

I'm no expert, so maybe a Sumner or Selgin would have a better answer on this, but I think the money came from The People, who were liquidating assets like crazy and parking the money in bank accounts. In late 2008, the Fed starts paying IOER, so the banks take all this cash and park it at the Fed. If this is the end of the story, it's highly contractionary. Instead, the Fed taps these reserves to buy up trillions of bonds and mortgages, putting the money back into the system and avoiding the otherwise contractionary impact of a huge increase in the demand for money.

I invite anyone who knows what I'm getting wrong here to jump in.

What happens if you wait a year from now to take them to the store? You might be able to purchase just as much real stuff, or 98% or 90% as much, or, God forbid, nothing at all. Doesn't seem like it has much worth to me other than a vehicle to convert your labor to consumables as quickly as possible, which is of course the point.

Nah, minor currency depreciation (~2% per year) is a feature, not a bug. Plenty of real assets depreciate faster than this and/or have higher carrying costs.

"The largest direct beneficiaries of the bailouts were the unsecured creditors of financial institutions."

Why are bondholders so special when everybody else took a haircut? I remember when Citibank's common stock was trading for a buck. Picked up a few for my retirement funds. Although I'm happy about that I'm not happy that creative destruction did not take its course as it should in a functioning market economy. Losers deserve to lose. Winners deserve to win. New entrants enter the game. Old losers exit stage left. That didn't happen.

The paper is a good refutation of the still oft repeated claim that we “earned a profit on the bailouts”.

However, I a much more concerned about the economic consequences of the bubble itself. How much was our long term productivity affected by diverting resources into non-productive assets instead of productive assets.

Look at the change in seigniorage as a bailout tax. That tax cost us about 400 billion above the current seigniorage, which was zero. It was 80 billion for about five years.

That tax should be relatively stable, like an ATM fee.

Another way to estimate costs is to look at declining ten year rates since the 80s. The declining rate means government is always paying yesterday's high rate for today's bailout, always paying the premium. Then with the balance sheet expansion, seigniorge went up, and we notice the ten year went up simultaneously with each QE. Finance engages in tax avoidance, one way or the other. Either they raise rates on government when they can or fill up excess reserves to neutralize seigniorage, as they did last month.
In all these cases, a good be is that finance is not dumb and they contain and estimate costs somewhere, just look for congestion when the Fed goes off equilibrium. The congestion point is where finance is estimating costs.

Using abstract theory no? Finding the bulge where the tree trunk became unround and the hologram became foul.

Yes, the loss was entirely monetized.

Under monetization, it's impossible to create a traditional accounting that shows who "lost."

In reality, the areas where we are hit by the loss: rule of law, free markets, trust in institutions, moral hazard, wealth and income inequality.

Shadow bankers, particularly the primary deals keep a QE cost variable. They use Black-Sholes in reverse, They compute the safe rate knowing the induced variance when the Fed pulls one of these stunts. This reverse process of call options was the invention of abstract tree, their ability to pull out the hidden costs was a mathematical breakthrough.

So, by measuring how the Fed causes temporary congestion, the cost 'force' is estimated, the rates set to their proper value to accommodate the cost. This ability, in the hands of the shadow bankers, but restricted for the central banker, is why all the super wealthy increased heir wealth by one quarter last year.

I find the whole idea of "bailout" murky.

When the Fed lends funds to a financial firm that needs liquidity, through the discount window, and is repaid fully with interest, is that a bailout? The Fed did a great deal of lending in 2008-2009 and was repaid.

Or are bailouts referring to explicit or implicit equity injections from Fed or Treasury into financial firms?

How does federal deposit insurance figure into all this? All depository firms have deposit insurance, and they pay fees to the FDIC for that insurance. If a bank goes insolvent, it is seized by the FDIC, which either merges it away or liquidates it. The FDIC may have to pay to liquidate the bank or to facilitate the merger. Is that a bailout? Is it bad, in which case we should get rid of FDIC and get rid of deposit insurance?

What happened to the houses? How many people gave back the keys and how many stayed? I guess people who stayed and had a lot of their mortgage written off got a lot of this money.

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