The Attempt to Rescue Banks Will Cost Taxpayers About 250 Billion Dollars

Even the 700 billion dollars allocated in the U.S. government’s legislative proposal for bank bailouts will not be enough to prevent further weakening of the economy, judging by experiences from similar desperate measures over the past twenty years, writes the Associated Press.

The agreement reached on Sunday between the U.S. government and Congressional leaders regarding a 700 billion dollar plan to rescue the financial system has brought relief to investors worldwide, but recovery from financial crises, which are so dangerous that politicians dare to rescue banks at the expense of taxpayers, usually takes years.

For example, when the government rescued the savings and loan industry in a similar manner in August 1989, the problems did not disappear overnight. Stock prices fell another 12 percent over the next 14 months, while the economy fell into a recession that lasted eight months, starting in July 1990. There is little reason to believe that this time will be different, given that it is difficult to value the illiquid assets that the government will buy from banks and that the U.S. economy is on the brink, if it is not already in recession.

Politicians believe that removing illiquid assets from banks’ balance sheets will allow those banks to raise fresh capital, and that this money will improve conditions in the credit market. For months, banks have been very cautious in approving new loans because they are either in losses or do not want to take risks by approving new loans. As a result, liquidity in the interbank money market has decreased, as has lending to individuals and business investments. However, as companies face declining sales due to the weakening economy and stricter lending conditions due to the credit crisis, further increases in unemployment in the U.S. can be expected. This could pose further problems for banks, as the unemployed will not be able to pay loan installments, and companies will not invest under such conditions.

Although this is the largest government intervention in the market since the Great Depression of the 1930s, it will take, at best, two years for the economy to recover, as was the case in Sweden, says Jonathan Macey, a professor at Yale University. In the early 1990s, the Swedish government spent about 10 billion dollars to save banks from losses caused by falling real estate prices. Before the measures yielded results, the Swedish economy was in recession for 20 months, about 60,000 companies went bankrupt, real estate prices fell by 19 percent, and stock prices fell by 45 percent from their record levels.

However, the recovery of the U.S. economy could take significantly longer, like Japan’s, which was hit by a banking and real estate market crisis in the early 1990s. The Japanese government intervened late, only in 1997, and by then the economy had sunk so deep that it took seven to eight years to recover. Taxpayers paid 168 billion dollars to clean up that ‘financial mess’, and today that period in Japan is referred to as the ‘lost decade’. Nevertheless, it is believed that the U.S. economy will not need as long to recover, as the government reacted faster than the Japanese did at the time.

Today’s U.S. government reacted more quickly than that of the 1980s, which rescued the economy from the savings and loan crisis. Although the first warning signs appeared in the mid-1980s, the government intervened only in August 1989. Over the next six years, more than 700 financial institutions went bankrupt, and the government sold about 400 billion dollars in assets of those failed institutions. The state lost between 125 and 150 billion dollars on that. When preparing for the intervention, it was estimated that 40 to 50 billion dollars would be needed.

When comparing the losses from that crisis with today’s attempt to rescue banks, worth 700 billion dollars, it follows that this legislative proposal will ultimately cost taxpayers about 250 billion dollars, which represents approximately 2 percent of the U.S. gross domestic product. (H)