FINANCIAL CRISIS: THE FALL OF THE HOUSE OF CARDS

February 18, 2010

The federal government has bailed out many industries, including banking, mortgage lenders, insurers, money market funds, automakers, credit card issuers, home builders, the states and so on.  This invites ongoing gambling at public expense by any business or entity that can reasonably expect a bailout.  Moreover, this is a prescription for fiscal insolvency, which could culminate in hyperinflation, says Laurence J. Kotlikoff, an economics professor at Boston University and a senior fellow with the National Center for Policy Analysis. 

AIG was effectively nationalized on September 16, 2008, at a cost of $85 billion to taxpayers.  Since AIG's nationalization, the government has engaged in a massive and potentially more expensive policy.  The policy entails providing systemic risk insurance to the financial sector -- that is, insurance against system-wide collapse.  Indeed, the federal government has already handed out, or publicly committed to hand out, more than $12 trillion to the financial sector, says Kotlikoff. 

Major components of the $12 trillion bailout include: 

  • The Treasury's $700 billion Troubled Asset Relief Program (TARP).
  • The Treasury's $400 billion in actual plus potential pledges of monies to cover Fannie Mae's and Freddie Mac's losses.
  • The Federal Reserve's $301 billion guarantee of Citigroup's troubled assets.
  • Nearly $200 billion spent by the Federal Reserve on AIG (with hundreds of billions more likely to come).
  • The $118 billion guarantee of Bank of America's poison securities.
  • The $29 billion spent by the Federal Reserve on Bear Stearns' toxic assets. 

The $12 trillion spent by the federal government bailing out the financial sector is close to one year's gross domestic product -- that is, the value of all the final goods and services produced by over 130 million Americans working an entire year, notes Kotlikoff. 

Systematic reform of the U.S. financial sector is critical.  Along with the financial market meltdown, trust in a system that routinely borrows short and lends long, guaranteeing repayment yet investing at risk, has evaporated and will not be regained.  What is needed is a system that doesn't gamble with the taxpayers' chips, but instead lets the public make their own risk-taking decisions based on securities that are transparent and whose properties are fully disclosed, says Kotlikoff.  

Source: Laurence J. Kotlikoff, "Financial Crisis: The Fall of the House of Cards," National Center for Policy Analysis, Brief Analysis No. 692, February 18, 2010. 

For text:

http://www.ncpa.org/pub/ba692  

 

Browse more articles on Tax and Spending Issues