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Publication: Progressive Review
Cost of Loan Bailout Could Be $25 Billion

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THE PROGRESSIVE REVIEW - July 24, 2008
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Cost of Loan Bailout, if Needed, Could Be $25 Billion
by: David M. Herszenhorn
The New York Times

Washington - The proposed government rescue of the nation's 
two mortgage finance giants will appear on the federal 
budget as a $25 billion cost to taxpayers, the independent 
Congressional Budget Office said on Tuesday even though 
officials conceded that there was no way of really knowing 
what, if anything, a bailout would cost. 

The budget office said there was a better than even chance 
that the rescue package would not be needed before the end 
of 2009 and would not cost taxpayers any money. But the 
office also estimated a 5 percent chance that the mortgage 
companies, Fannie Mae and Freddie Mac, could lose $100 
billion, which would cost taxpayers far more than $25 
billion. 

The House is expected to act this week on housing 
legislation that includes the proposed rescue plan. 
Legislative language has been finalized, but the 
Congressional Budget Office said its estimates were 
based on the plan by the Treasury Department and that 
it did not expect significant changes in the final bill. 

According to the estimate, which was delivered in the 
form of a letter to the House Budget Committee chairman, 
Representative John M. Spratt Jr., Democrat of South 
Carolina, the director of the budget office, Peter R. 
Orszag, predicted that "a significant chance, probably
better than 50 percent, that the proposed new Treasury 
authority would not be used before it expired at the end 
of December 2009." 

Mr. Orszag, at a briefing with reporters, acknowledged 
that pinpointing the eventual cost of the package was 
impossible. "There is very significant uncertainty 
involved here," he said. 

The uncertainty runs in both directions, with some 
government officials and market analysts suggesting 
that Fannie Mae and Freddie Mac are fundamentally 
sound and will perform well over the long-term. Others, 
including some private equity managers, are pessimistic 
and predict heavy losses.

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The rescue plan, put forward last week by the Treasury 
secretary, Henry M. Paulson Jr., would allow the Treasury 
Department to spend hundreds of billions of dollars to 
shore up the mortgage companies should they be at risk 
of collapse, either by extending credit or by purchasing 
equity in the companies, which are publicly traded.

Mr. Orszag said that the analysis by his office did not 
distinguish between the different forms of aid that might 
be offered - a credit line or a stock purchase - and that 
the analysis showed no short-term potential financial 
benefit for taxpayers even if Fannie Mae and Freddie Mac 
perform well. 

But he said the analysis found substantial risk for tax-
payers if the companies had steep losses and would not 
say if his office had analyzed the implications of a full 
government takeover of the companies.

How much the government will end up spending on a rescue, 
if one is needed, would depend on many factors, he said, 
including sentiment on Wall Street. "A key question 
becomes how does the market view the entities?" he said.

Fannie Mae and Freddie Mac are commonly referred to as 
government-sponsored entities, because of the long implicit 
guarantee that the federal government would step in to 
save them if they were ever in danger of collapse. 

One thing that is certain as a result of the rescue 
proposal is that the guarantee of government aid is 
now much more explicit, and Mr. Orszag said that the 
government's assurance that it would not let the 
companies fail would have to be included in any analysis 
of their long-term financial prospects. 

Most immediately, the $25 billion cost estimate provides 
a precise amount that Congress will have to offset with 
spending cuts or tax increases if lawmakers intend to 
comply with "pay as you go" budget rules in the House. 
Lawmakers could also decide that the $25 billion should 
be viewed as emergency spending and simply added to the 
national debt. 

There was little immediate reaction to the projections on 
Capitol Hill as lawmakers and staff members reviewed the 
complicated calculations and the various assumptions they 
were based on. 

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Mr. Spratt, the chairman of the Budget Committee, issued 
a statement praising the Congressional Budget Office for 
moving quickly to produce its analysis. "Estimating the 
fiscal impact of this proposal is complex and involves 
considerable uncertainty," Mr. Spratt said. "And not 
everyone will necessarily agree with every aspect of 
C.B.O.'s analysis."

But he added: "C.B.O. is performing its important 
institutional role by providing in a timely manner 
its best professional and independent assessment."

The analysis by the Congressional Budget Office also 
offered a sobering assessment of the mortgage giants 
based on several different metrics.

Under generally accepted accounting principals, Mr. Orszag 
said that the net worth of the mortgage giants at the end 
of the first quarter of 2008 was about $55 billion. He 
also said that the companies held more than $80 billion 
in capital at the end of March and for regulatory purposes 
were considered to be "adequately capitalized" by the 
Department of Housing and Urban Development. 

But on a fair value basis, the value of the mortgage 
companies' assets exceeded their liabilities at the end 
of March by just $7 billion, a thin cushion considering 
liabilities at the time of $1.6 trillion, and an indication 
of why there have been numerous calls for the companies to 
raise additional capital. Mr. Orszag also noted that on 
July 11, before the Bush administration proposed its rescue 
plan, the total value of shares in Fannie Mae and Freddie 
Mac had fallen to a low of $11 billion. Shares in the 
companies are now worth about $20 billion. 

The House is expected to vote on the larger package of 
housing legislation, including the rescue plan for the 
mortgage companies, as early as Wednesday, and the Senate 
is expected to quickly follow and send the bill to 
President Bush. 

Among the issues that lawmakers have been debating is 
whether to exempt from the federal debt limit any 
expenditure that the Treasury Department makes on behalf 
of the mortgage companies. The current debt limit is 
$9.815 trillion and outstanding federal debt is roughly 
$9.5 trillion, leaving a cushion of $310 billion. 

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Congressional Democrats have expressed opposition to 
exempting the rescue plan from the debt limit, saying 
administration officials should come back to Congress 
for emergency authorization if additional spending is 
needed. Officials said it was probable that a compromise
would be reached and the debt limit would still apply.

The housing legislation also includes the creation of a 
regulator for the mortgage companies, an agency apart 
from the Department of Housing and Urban Development, 
which oversees the mortgage giants. 

Some critics have questioned whether the new regulator 
would have sufficient authority to swiftly increase 
capital requirements - the amount of cash that the 
mortgage companies need to maintain to protect against 
losses. 

In his letter to Mr. Spratt, Mr. Orszag suggested that 
simply enacting the proposed rescue plan could bolster 
the confidence of Wall Street in Fannie Mae and Freddie 
Mac. 

"Private markets might be sufficiently reassured to 
provide the GSE's with adequate capital to continue 
operations without any infusion of funds from the 
Treasury," he wrote. "during that time, it is possible 
that expectations about the duration and depth of the 
housing market downturn may brighten."

But Mr. Orszag said his office had also consulted with 
market investors with a different outlook. "Many analysis 
and traders believe there is a significant likelihood 
that conditions in the housing and financial markets 
could deteriorate more than already reflected on the 
GSEs' balance sheets," he wrote, "and such continuing 
problems would increase the probability that this new 
authority would have to be used." 

Taking into account all of the different possibilities 
and sentiments, and measuring them against the budget 
"scorekeeping" rules, Mr. Orszag said his office had 
concluded "that the expected value of the federal 
budgetary cost from enacting this proposal would be 
$25 billion over fiscal years 2009 and 2010." 

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