S&P gauges bailout of Wall Street firms

• Article
• Comments ()
• Click-2-Listen
• Videos

By

The potential cost to U.S. taxpayers of bailing out Wall Street firms stricken by the credit crisis could grow to as much as $400 billion in a deep and prolonged recession, Standard & Poor's estimated yesterday.

That bill would soar by another $1.4 trillion if it included the cost of bailing out Fannie Mae, Freddie Mac and other government credit agencies, whose losses could be so massive that the U.S. government could lose its AAA rating in what would be a calamity for the U.S. Treasury and the dollar.

Standard & Poor's is one of two Wall Street credit agencies that assign ratings to the U.S. government. The ratings not only reflect on the government's strength, but they largely determine its debt costs. To assign a rating, S&P must make realistic estimates of the financial threats that arise in dire circumstances, including the possibility of a severe recession resulting from the housing collapse.

"Even under a severe stress scenario, the contingent fiscal risks of broker-dealers will not threaten the AAA rating on the U.S. government," said John B. Chambers, chairman of S&P's sovereign ratings committee, but because the government credit agencies have grown to such an enormous size, their insolvency would put pressure on the U.S. government's own finances.

While the Federal Reserve's rescue of Bear Stearns & Co. last month with a $29 billion guaranteed loan had comparatively small costs to taxpayers, the action served to cement the impression on Wall Street that the U.S. government will not allow any major brokerages to fail, and it will almost certainly step in to prevent the failure of Fannie or Freddie, S&P said.

Treasury and Fannie spokespeople declined to comment on the report. Freddie Mac called the report "a scenario analysis, not a prediction," and said it remains "well capitalized."

Treasury and Fed officials in the past have taken issue with the widespread view on Wall Street that Fannie Mae and Freddie Mac are backed by the government. At the same time, they have repeatedly warned about the risks posed by their enormous holdings of more than $6 trillion, and have sought to rein in the agencies to reduce potential taxpayer liabilities.

The cost of rescuing the credit agencies, including the Federal Home Loan Banks, would be up to 10 percent of the economy's $14 trillion annual output, or $1.4 trillion, S&P said. The maximum cost of assisting failed brokerages, by comparison, would be less than 3 percent of output, or $420 billion.

Peter Schiff, president of Euro Pacific Capital, questioned why the government has opened itself up to such big liabilities and at the same time set in motion another round of risk-taking by brokerages that may require future big bailouts. The government for decades has provided insurance for bank depositors but until last month had provided no guarantee for brokerages.

"Leveraged speculators need to know that it is not 'heads they win, tails the taxpayers lose,' " he said. "By bailing out lenders who extend excessive credit, the Fed simply invites more of that behavior."

Mr. Schiff contended that the Fed should have forced risk-taking lenders — especially those who amplified their risks by leveraging their investments many times over — to live with their losses.

"By interfering with this process, the Fed simply guarantees more losses and even bigger bailouts in the future," he said. "Wall Street executives amassed fortunes by making extremely risky bets. Now that those bets have soured, why is it taxpayers that have to swallow the losses?"

Congress and the Bush administration recently increased the potential costs to taxpayers by increasing the risks to Fannie and Freddie, reducing their capital requirements and allowing them to purchase riskier loans made to troubled subprime and jumbo borrowers, S&P said.

Even so, analysts say the housing credit agencies have amassed a relatively small share of risky subprime and exotic mortgages since 2003, with the majority of those mortgages held by banks, brokerages, hedge funds and other investment funds.

The goal of most of the government's rescue actions has been to avert a severe recession, S&P said, but they have also greatly increased potential costs to taxpayers by opening the door to bigger bailouts. The agency noted that the cumulative risks and losses to banks and brokerages keeps deepening each month the housing recession worsens.