 Casey Files:
The Real Cost of the 2008
Recession
Olivier Garret
CEO, Casey Research
The
Casey Report
Dec 10, 2008
It took the statisticians of
the National Bureau of Economic Research almost a year to confirm
what the rest of us already knew, that the US registered a significant
decline in economic activity, thus officially entering a period
of recession. While I am pleased that the members of NBER take
their duties seriously, thereby ensuring that they don't leap
to any hasty conclusions, I only wish that similar moderation
could be displayed by their colleagues at the Fed and the Treasury.
Unfortunately, the facts prove
otherwise. Three months before the recession was officially declared,
Paulson and Bernanke have embarked on the largest bailout program
ever conceived with the blessing of a lame-duck president and
a complicit Congress - a program which so far will cost taxpayers
$8.5 trillion. This staggering sum encompasses: loans backed
by worthless assets ($2.3T), equity investments in bankrupt companies
with negative net worth ($3.0T), and guarantees on crumbling
derivatives and other hollow collateral ($3.2T).
Back in September I was stunned
that Paulson was able to make his case and win the support of
Congress for a $700 billion bailout package (more than the total
war spending in Iraq to date).
How could Americans (or more
accurately, their representatives) agree to give such a broad
mandate with so few checks and balances? Have we become completely
numb?
While I realize that many of
our compatriots have been running large credit card balances
and interest-only mortgages with little thought as to how they
would repay their debt, one would expect a little more restraint
when dealing with the financial future of the largest economy
in the world.
Operating under the assumption
that our largest financial institutions are "too big to
fail", in the span of a few weeks we went from pledging
to spend $1 trillion to $3 trillion - a commitment which then
grew to $5 trillion before ballooning to a staggering $8.5 trillion.
At the rate we are going, we
will be dealing with double digits - in trillions- before the
end of the year.
And while all off that money
is not yet spent, make no mistake - these are real commitments
with serious liabilities attached to them.
I have heard the argument that
an equity infusion is not the same as spending money. While I
would agree that in an arms-length transaction this might actually
be the case, our government is definitely paying a large premium.
What is the real value of Citicorp or AIG? Since they are quasi-bankrupt
(and would be totally bankrupt without massive injections from
the Fed), a reasonable businessperson might pay a token price
for their equity and the assumption of their enormous liabilities.
Before doing so however, a buyer would have to see some significant
value in buying these entities as a continuing business. In most
cases, a buyer would not want to assume the company's liabilities
but would prefer to buy selective unencumbered assets in a bankruptcy
proceeding. Any money our government pays above what a reasonable
person would pay in an arms-length transaction is real spending
and should more accurately be called a grant.
While defenders of the too-big-to-fail
policies argue that providing guarantees is not the same as granting
money, the reality is that these guarantees are necessary to
prevent the collapse of financial institutions currently lacking
the necessary collateral to meet their loan covenants. Should
their loans be called, we could actually find out the real value
of their assets. The fact is that in-spite of Paulson's and Bernanke's
efforts, deleveraging is already happening. Although at a slower
pace, one asset class after another is being adjusted down towards
its intrinsic value, which is usually not much. Make no mistake;
many of these guarantees will eventually be called in by lenders.
In due time, unless our government is able to inflates its way
out of this bottomless pit, it will have to honor most of these
guarantees.
So how does $8.5 trillion dollars
compare with the cost of some of the major conflicts and programs
initiated by the US government since its inception? To try and
grasp the enormity of this figure, let's look at some other financial
commitments undertaken by our government in the past:
As illustrated above, one can
see that in today's dollar, we have already committed to spending
levels that surpass the cumulative cost of all
of the major wars and government initiatives since the American
Revolution.
Recently, the Congressional
Research Service estimated the cost of all of the major wars
our country has fought in 2008 dollars. The chart above shows
that the entire cost of WWII over four to five years was less
than half the current pledges made by Paulson and Bernanke in
the last three months!
In spite of years of conflict,
the Vietnam and the Iraq wars have each cost less than the bailout
package that was approved by Congress in two weeks. The Civil
War that devastated our country had a total price tag (for both
the Union and Confederacy) of $60.4 billion, while the Revolutionary
War was fought for a mere $1.8 billion.
In its fifty or so years of
existence, NASA has only managed to spend $885 billion - a figure
which got us to the moon and beyond.
The New Deal had a price tag
of only $500 billion. The Marshall Plan that enabled the reconstruction
of Europe following WWII for $13 billion, comes out to approximately
$125 billion in 2008 dollars. The cost of fixing the S&L
crisis was $235 billion.
The best deal ever for a government
program was the Louisiana Purchase, a deal with the French that
gave us 23% of the surface of today's US for only $15 million
($284 million in today's dollars). Why couldn't Paulson and Bernanke
display the financial acumen of a Thomas Jefferson?
How will our country repay
its debts? The current bailout represents 62% of our GDP. Our
current deficit of almost $11 trillion may exceed our GDP next
year.
Recently the Treasury has been
able to place new debt; investors have liquidated equities and
bonds and sought refuge in the relative safety of the dollar
and government bonds.
As we move forward however,
our government will need to attract trillions of dollars annually
to fund its programs and commitments. The foreigners who have
financed our irresponsible spending for many years will no longer
be able to afford it, let alone finance more of our reckless
behavior.
As a matter of fact, several
countries have already announced their own bailout packages to
prop up their domestic economy. And, unlike during WWII, when
Americans invested their savings to support the war effort and
fund our government's deficit, our citizens are in debt themselves
with no savings left to invest.
In the near future, the Fed
will have no choice but to turn on the printing presses and start
operating them around the clock to create the money that can't
be raised in the capital market.
These actions will lead to
a significant debasement of the dollar and a major appreciation
of gold and all commodities (real assets).
Once this inflationary cycle
starts, foreigners will realize that their investments in T-bills
are depreciating rapidly. There will be a massive exodus that
will put more pressure on the dollar and on interest rates. Our
weakened US economy will be faced with the rising cost of capital
and a painful period of stagflation. Trillions of dollars will
have been wasted. Our government will have mortgaged America
and the ensuing debt will have to be paid by future generations.
Not a very bright picture,
to be sure, but the Casey Research team strongly believes that
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and even profiting in times of crisis by making the trend your
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Dec 10, 2008
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