- The Washington Times - Thursday, September 25, 2008

COMMENTARY:

The economic rescue plan to buy up bad mortgages and other illiquid assets will push the government’s debt to more than $11 trillion next year — making major new spending initiatives problematic, if not impossible.

Economists and former budget officials say the true cost of Treasury Secretary Henry Paulson’s unprecedented plan could be more than his $700 billion estimate, possibly closer to $1 trillion when the final bills are tallied. And that will be in addition to hundreds of billion of dollars the government has spent to grease the private buyout of Bear Stearns and take over Fannie Mae, Freddie Mac and insurance giant American International Group.

There is no doubt that in a $14-trillion-a-year economy, the government has the resources to buy up the toxic securities that threaten to undermine the U.S. economy. And Mr. Paulson is correct in saying the net cost will be a lot less than the initial payout once these assets are eventually sold when the economy has stabilized and housing values begin rising again.

That’s what happened in the savings-and-loan debacle in the late 1980s when S&L banks failed and the feds had to shell out hundreds of billions of dollars in a massive bailout. In the end, the cost to taxpayers was $130 billion when the Resolution Trust Corp. liquidated bank assets. The gloom-and-doomers said it would take a generation for the country to undue the financial damage, but it took four or five years to undo, and the economy, and the banking industry, emerged stronger than ever.

Nevertheless, there is no doubt the buyout costs of Mr. Paulson’s plan will initially add to the government’s red ink and the revenue loss from a weak economy will push the annual budget deficit to record levels.

“Whoever walks into the Oval Office in January is going to be facing the largest deficit that any president will have faced in the history of the country,” said former White House chief of staff Leon Panetta, who also served as President Clinton’s budget director.

Under “the estimates I’ve seen as a result of the economic weaknesses we are suffering, the budget deficit is easily going to approach $700 billion when the new president comes in,” Mr. Panetta told me.

“We are clearly going to be approaching an $11 trillion national debt [next January] that obviously carries implications on interest payments as well as the stability of the dollar because that money will have to be borrowed, largely from abroad,” he said. Right now, the government’s national debt is more than $9.6 trillion, but that number will easily surpass $11 trillion next year once the bailout’s borrowing costs are fully factored in.

Mr. Panetta said the costs of the bailout plan will be so huge that “the new president will have to make a fundamental decision about whether he can afford to continue to borrow and spend, or whether he is going to be willing to make the tough decisions to put the country on the road to fiscal responsibility.”

Barack Obama, for example, has made a lot of spending promises to deal with every problem under the sun — costing taxpayers hundreds of billions of dollars more in his first term. But Mr. Panetta told me the freshman senator is in for a rude awakening if he wins on Nov. 4. “I don’t think there’s any question that Barack Obama is going to be severely limited [in keeping] the promises he made in his campaign, and the same is true for John McCain,” he said.

That’s why the central debate over the administration’s buyout plan, apart from whether it will work, is its up-front cost to taxpayers — despite widespread agreement among fiscal experts that Mr. Paulson is right when he says most of this money will be recouped by the government.

The plan’s $700 billion price tag “is a gross cost, not a net cost. The net cost will be substantially lower than that because the plan would spend $700 billion to purchase bad assets such as mortgage loans, hold on to them, then sell them later back to the market,” said chief budget analyst Brian Riedl at the Heritage Foundation.

Mr. Paulson is going to buy up these debt instruments at, say, 50 cents on the dollar, maybe as low as 20 cents, then sell them in a year or two for 55 cents on the dollar or more, he said.

Desmond Lachman, economist at the American Enterprise Institute, agrees: “They are going to buy assets from banks at very low prices and then when the situation normalizes, they are hoping they can sell them at least at the cost they paid. In the end, it might not cost the taxpayers a lot,” he told me.

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