Measuring the true cost of government bailout.

• Author: Block, Cheryl D.

1. INTRODUCTION AND BRIEF HISTORY A. Introduction B. Brief History of Recent Events II. MISCONCEPTIONS ABOUT BAILOUTS AND BAILOUT COSTS A. Bailout v. Stimulus 1. Differences in Definition 2. Differences in Cost Assessment B. Classifying Bailout Types by Cost 1. Profitable Bailouts 2. Low- or No-Cost Bailouts 3. Nongeneral Revenue or "Special Fund" Bailouts. 4. General Revenue Bailouts 5. Combination Bailouts III. BAILOUT COSTS: WHERE IN THE BUDGET? A. Introduction B. The Federal Reserve 1. The Federal Reserve and Monetary Policy 2. The Federal Reserve Bank's Role in Recent Bailout Activity 3. Expansion of Federal Reserve Activity in Response to Crisis 4. Budget Implications of Federal Reserve Programs a. The Federal Reserve and Its Balance Sheets b. The Impact of the Federal Reserve Bank's Actions on the Federal Budget 5. Federal Reserve Bank Budget Status and Reporting C. Other "Off-Budget" Bailout Issues 1. Housing-Related GSEs 2. Government Takeover of Fannie Mae and Freddie Mac 3. Budget Implications of the GSE Takeover and Other Housing-Related Government Interventions IV. ESTIMATING THE COSTS OF OVERT BAILOUTS A. Introduction: Budget Accounting for Contingent Risks and Uncertain Valuations B. Direct Loans, Loan Guarantees, and Other Contingent Liabilities 1. Federal Government Loan and Insurance Programs 2. Cash v. Accrual Accounting for Loans and Other Credit Programs 3. TARP, Credit Reform, and Asset Valuation 4. Mission Fragmentation V. ESTIMATING THE COSTS OF COVERT OR HIDDEN BAILOUTS A. Relief Through Tax Expenditures 1. In General 2. Net Operating Loss (NOL) Carryovers: Internal Revenue Code [section] 172 3. Loss Limitations Following Corporate Ownership Changes: Internal Revenue Code [section] 382 4. Reporting Ordinary Losses From Fannie Mae and Freddie Mac Stock Sales 5. Budgetary Concerns B. Relief Through Tax Administration and Regulations 1. Bailout Through Relaxed Agency Interpretation of Tax Provisions 2. IRS Interpretive Authority and the Administrative Procedure Act 3. Cost-Benefit Analysis and the IRS 4. A Case Study of Hidden Bailout and the Need for Cost-Benefit Analysis a. Relaxed IRS Loss Restriction Rule Interpretations b. Estimating the Costs and Lessons From Notice 2008-83 c. Notice 2008-83 and Budget Scoring C. Other Hidden Bailout Costs 1. Nontax Regulatory Relief 2. Moral Hazard and Implicit Guarantees VI. WALL STREET REFORM ACT--A POSTCRIPT VII. CONCLUSION I. INTRODUCTION AND BRIEF HISTORY

   1. Introduction

      When the American Dialect Society tallied votes for its nineteenth annual "word of the year," the clear victor for 2008 was "bailout." (1) The economic crisis that began in 2007 and escalated through 2009 led even those who are ordinarily free-market purists to concede the need for government intervention. Not since the Great Depression had the United States experienced such a severe economic downturn affecting virtually all sectors of the economy. (2)

      Although the extent and variety of recent government bailouts have been extraordinary, the "bailout phenomenon" is nothing new. History offers numerous illustrations of government intervention to assist individual businesses in financial distress, including the Chrysler Corporation, (3) Lockheed Aircraft Corporation, (4) New York City, (5) Penn Central, and other struggling northeastern railroads. (6) Congress has also provided industry-wide assistance, including legislation to aid the airline industry, hard hit by the aftermath of the 2001 terrorist attacks. (7) Until the most recent bailouts, perhaps the most costly industry-wide government intervention in modern memory was the savings and loan bailout in the late 1980s. (8)

      As events evolved in 2008 and 2009, voters became increasingly angry about lax regulatory oversight of Wall Street and the escalating cost of government-funded bailouts. (9) This Article focuses on issues related to providing accurate cost assessments and budget accounting for bailouts in general and for recent bailouts in particular. Congress has since passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. (10) This historic financial regulatory reform bill begins with a preamble declaring a firm purpose to "end 'too big to fail'" and "to protect the American taxpayer by ending bailouts." (11) With this legislation, Congress announced that there will be no more government-funded rescues of private industry. At the same time, the legislation seeks to prevent--or at least mitigate--potential future economic crises by providing government "authority to liquidate failing financial companies that pose a significant risk to the financial stability of the United States." (12) Expenses incurred in connection with the government's orderly liquidation authority are not to be paid from general revenues, but instead from a new "orderly liquidation fund" to be maintained by the Treasury Department for the Federal Deposit Insurance Corporation (FDIC). (13) For purposes of this fund, the FDIC has authority to borrow by issuing obligations. (14) To ensure that funds necessary to repay these obligations not be taken from general revenue, the legislation gives the FDIC further authority to impose a risk-based assessment on large bank holding companies and nonbank financial companies under supervision of the Federal Reserve Bank. (15) Lest there be any doubt, Congress also included an explicit declaration that "taxpayers shall bear no losses from the exercise of any authority under this title." (16) As he signed the Wall Street Reform legislation, President Obama asserted that "because of this law, the American people will never again be asked to foot the bill for Wall Street's mistakes. There will be no more tax-funded bailouts--period." (17)

      If such legislative and executive branch claims of "no more taxpayer-funded bailout" are accurate, one might think that the budgetary accounting issues addressed in this Article are moot. Yet, bailout cost measurement concerns remain relevant for several reasons. If nothing else, the public is entitled to some reasonable assessment of how much has already been spent for bailout-type government interventions. In addition, federal loan and loan guarantee programs for struggling small businesses are likely to continue as an important part of our economic landscape. And, the government continues to hold conservatorship interests in mortgage giants Fannie Mae and Freddie Mac, the value of which should be monitored for budgetary purposes. (18) More importantly, political "no more bailout" assertions--even those ultimately included in statutory text--simply are not credible as precommitment devices. Statutory declarations can always be amended. As much as Congress would like to eliminate any "too-big-to-fail" policy, the reality is that there may--and probably will--come a time when the failure of a particular firm or industry would be so economically devastating that Congress would step in to save it, despite earlier protestations to the contrary. (19) In addition, the legislative orderly liquidation procedures are limited to financial companies, insurance companies, and certain brokers and dealers. (20) Thus, the legislation does not apply to potential bailouts of the automotive industry, airlines, or any other companies or industries whose failure might create systemic risk. Perhaps most importantly, the reform legislation does not address the many ways in which Congress provides potentially costly bailout-type relief through indirect or covert interventions.

      This Article explores the challenges involved in providing reasonably accurate budgetary information with respect to different types of overt and covert bailout expenditures. Despite the challenges, it is important that every effort be made to record the budgetary impact of each type of government intervention as accurately as possible. As one analyst recently noted,

      [i]t will be critical to economic recovery and the long-term health of our financial system that we allocate money to the different rescue programs in a way that maximizes the "bang for the buck[,]" [which is] best done by comparing the expected costs of various programs, rather than focusing on their maximum possible losses. (21) A reasonable assessment of the relative costs of different approaches is essential to enable legislators, administrators, and regulators to make informed policy choices about the best use and allocation of resources. Finally, reasonable estimation of the costs of various "rescue" efforts is important if overall budgetary information is to reflect a reasonably accurate picture of the nation's overall short- and long-term fiscal health.

      In addition to analyzing cost assessment challenges presented by the more obvious bailout programs, this Article explores the special cost estimation challenges for other, more covert, actions that serve a "bailout" function. Part II will first briefly address the distinction between bailout and stimulus and misconceptions about the ways in which government economic rescue efforts may or may not impose costs on the general taxpaying public. Part III identifies concerns with "off-budget" bailout-type expenditures and considers the proper location in the federal budget for reporting various types of government bailout interventions. one question considered in this Part, for example, is the proper budgetary treatment of Federal Reserve, as opposed to Treasury Department, bailout-type actions. Part IV considers budgetary challenges in proper accounting and cost estimation for different types of overt government bailouts. Finally, Part V explores similar questions with respect to more covert bailouts.

      For purposes of this Article, my working definition of "bailout" is one that I developed in my earlier work: "a form of government assistance or intervention specifically designed or intended to assist enterprises facing financial distress and to prevent enterprise failure." (22) This...