Business | Markets
Bailout proves drain on US budget
The global financial crisis is turning into a bigger drain on the US federal budget than experts estimated two weeks ago, increasing the deficit and national debt.
- Bloomberg
- Published: 23:53 October 10, 2008
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New York: The global financial crisis is turning into a bigger drain on the US federal budget than experts estimated two weeks ago, increasing the deficit and national debt.
Bailouts of American International Group, Fannie Mae and Freddie Mac are likely to be more expensive than expected. States are turning to Washington for fiscal help.
The Federal Reserve said last week it will begin buying commercial paper, the short-term loans companies used to conduct day-to-day business, further increasing costs. And analysts now say the $700 billion (Dh2.57 trillion) bank-rescue plan passed by Congress a week agomay have to be significantly larger.
"I always assumed they would be asking for more money along the way if it was necessary, and it looks like it's going to be necessary," said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. "At the moment, there's nothing happening here that's positive for the budget. Nothing."
The 2009 budget deficit could be close to $2 trillion, or 12.5 per cent of gross domestic product, more than twice the record of six per cent set in 1983, according to David Greenlaw, Morgan Stanley's chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.
Borrowing to rise
That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. "The Treasury's going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation," Greenlaw said last week. "The supply will trigger some elevation in yields."
Payments the government allocated to keep vital companies solvent are beginning to look insufficient.
AIG, the giant insurance company taken over by the government in mid-Sep-tember, said last week it may access $37.8 billion from the Federal Reserve Bank of New York, in addition to the $85 billion the government already loaned it to stave off bankruptcy.
"You're in for a dime, you're in for a dollar on this one," said David Havens, a credit analyst at UBS AG.
The financial health and earnings prospects of Fannie Mae and Freddie Mac - seized by the government on September 7 to prevent them from failing - worsened in the second and third quarters, the companies' government regulator said last week.
The companies and regulators are recalculating the value of all of their assets to factor in price erosion. That may mean the government will have to spend more to keep the firms solvent.
A week ago, the Fed announced it will create a special fund to buy commercial paper, the credit that businesses use to finance payrolls and ongoing expenses. The Treasury will deposit money into the Fed's New York district bank to help set up the new unit. A Fed official said Treasury funding for the programme could be "substantial."
California, Alabama and Massachusetts are urging the Fed and Treasury to include their securities in rescue plans designed for banks and businesses. The $2.66 trillion US market for state and city bonds has been all but frozen since Lehman Brothers, weighed down by losses in mortgage-backed bonds, declared history's largest bankruptcy.
California has said it needs to sell $7 billion in notes to maintain its schools, health system and other public services. The Bush administration said it is reviewing the states' financial positions.
Meanwhile, Treasury Secretary Henry Paulson indicated last week that he is considering buying stakes in a wide range of banks in coming weeks to help recapitalise them.
Such a move is allowed under the $700 billion bailout package Congress passed last week. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said such action is necessary - and will likely turn out to increase the measure's cost. Spending beyond the amount set in the bailout bill would require further Congressional approval.
"We have to recapitalise the banks," Phelps told Bloomberg Television last week. "I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction."
The additional borrowing could push the national debt well past 70 per cent of GDP, the highest since the immediate aftermath of World War II, when the US was still paying off war debt.
Gross US debt, which includes debt held by the public and by government agencies, this year reached about $9.6 trillion, or about 68 per cent of gross domestic product. The rescue legislation increased the government's debt limit to more than $11.3 trillion from $10.6 trillion.
On top of all that, budget watchdogs say the sheer size of the interventions is making Washington more profligate than usual. To attract votes in Congress, leaders added several costly items to the $700 billion rescue, including extensions of some tax credits and tax breaks for makers of wooden arrows and stock-car racetrack owners.
Under normal circumstances, there would have been more resistance to such expenses, said Robert Bixby, executive director of the Concord Coalition, a non-partisan budget watchdog. The rescue legislation "creates a mask for all sorts of fiscal irresponsibility," said Bixby. "It covers up a multitude of sins."
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