The Bailout: Expenditure or Investment?

With respect to estimates concerning the total cost of the various bailouts, etc. for the financial system, in particular whether the spending should be treated as an expenditure or an investment, Steve Waldman says:

Expenditure vs investment — thinking clearly: ...Paul Kedrosky is a reasonable fellow, and takes care to note that the numbers "are in current dollars, and all treat expenditures and investments as equivalent." Kevin Drum is even more reasonable:

This stuff has gotten completely out of hand, with "estimates" of the bailout these days ranging from $3 trillion to $7 trillion even though the vast bulk of this sum comes in the form of loan guarantees, lending facilities, and capital injections. The government will almost certainly end up spending a lot of money rescuing the financial system (I wouldn't be surprised if the final tab comes to $1 trillion over five years, maybe $2 trillion at the outside), but it's not $7 trillion or anything close to it. People really need to stop throwing around these numbers as if the bailout is comparable to World War II or something. That's not reality based, folks.

But reasonable and right are sometimes different... We have some idea what we paid for, for example, with the $851,000,000,000 for NASA. We bought space shuttles, satellite systems, a moon shot, planetary probes, a lot of research and development, some air bases and research facilities.

What are we buying when the government purchases mortgage-backed securities, or buys preferred shares of banks that can only pay if a portfolio of real-estate loans does not totally sour? We are buying "paper", right?

No. We are not buying paper. ... All of the iffy securities that are weighing down the banking system represents money already spent on real projects or consumption. When the government purchases a security, it is taking the place of the party that originally fronted money for that expenditure. Every penny of government "investment" is retroactive expenditure on housing, real-estate, consumer credit, whatever.

If a government were to borrow funds in order to build a new stadium, we'd call that an "expenditure", even if we fully expect use fees and incremental tax revenues to eventually turn a profit for the fisc. Politicians supporting the project would call it an "investment", quite justifiably. But the project would still count as government spending.

If a private party builds the same stadium, and then is reimbursed by the government in exchange for rights to future revenue, that doesn't change the economic substance of the transaction at all. But in the second case, the government would buy "paper" — it would enter into a contract trading current government funds for future revenues. That "security" doesn't make the transaction any more or less an investment than if the government had purchased the stadium itself.

So, in economic substance, the government is currently spending through a financial time machine on the exurban subdivisions and auto loans of several years past. ...

I hope that the infrastructure we build next year turns out to be a wise investment, both in financial and use-value terms. It might be, but just because we hope to recoup the cost, we won't pretend that no money was actually spent. We'll call the whole thing an expenditure, even though that will probably overstate the ultimate burden. But if a power grid counts as an expenditure on government books, so should a security derived from a mortgage or credit card loan made two years ago. You ... can't claim that securities are "investments" while a power grid, or NASA, or even World War II are mere "expenditures". ...

Figures of 7 or 8 trillion dollars recently bandied about by the Communists at Bloomberg are overstated, since they do not distinguish between expenditures and guarantees, which are contingent liabilities. The government's contingent liabilities aren't usually counted as spending until the contingency has been triggered. But the amount of money already spent or committed on "financial investments" to date is more than $3 trillion dollars, and it is perfectly right to call that government spending on the financial bail-out.

The scale of the largely unlegislated current government program to save the financial system is breathtaking and quite unprecedented. Taxpayers might be made whole, in financial terms, or might reap sufficient dividends in terms of suffering avoided to justify the program. But don't let anyone convince you that the scale of this intervention is "overstated" because it is all "investment". NASA and the Marshall Plan were investments too, and pretty good ones.

But shouldn't the example be a little different? If the private sector builds, say, a stadium and then the government buys it, then yes, that is expenditure. But suppose the government purchase comes with a clause that says it will sell the stadium back to the private sector at a date certain (or by a date certain). It's still an expenditure of the same amount in the present, but the purchase price does not represent the expected long-run burden of the transaction, and isn't that what we really care about? The government plans to sell the financial paper, not hold it forever, and what really matters is how much the paper will be worth in the future (if the stadium value falls to zero, then the current expenditure does represent the long-run burden; however, the value of the government holdings will not fall to zero or anything even close to that).

So I don't care what you call it, expenditure, investment, a repo, temporary custody of a volatile asset, whatever, what I care about is how much the bailout will cost once the government has disposed of all of the assets it has purchased. That's not something we can know with certainty, but unless the value of the securities the government is holding falls much, much further than anyone expects, the amount of the current expenditure greatly overstates the long-run burden.

Comments

[a]

"The government plans to sell the financial paper, not hold it forever, and what really matters is how much the paper will be worth in the future."

Right. What matters is the purchase price vs what the paper will be worth. But given the lack of transparency of these operations, we don't know what paper the government has got its hands on, nor how much it paid (what the valuation is, what the haircut is, etc.) Now we can all go and trust Bernanke because he is a brilliant economist who is the world's expert on the Great Depression. And I know I may hurt economist's feelings. But my guess is that, against the dealsters of Wall Street, Bernanke got his pocket picked.

[OhNoNotAgain]

Well, if our experience with the S&L crisis and the RTC is any guide, we should expect to get a good portion of our money back. But, as they say, past history is no guide to future performance.

In my mind, this is why it is so important that we get the economy back on track towards *sustainable* growth from investments in new technologies. Sustainable economic growth will act to inflate, in the good sense, the values of these assets such that we all come out further ahead than if the economy were to languish for an extended period of time.

[kharris]

"You see, Michael, you'll be part of
Railways through Africa!
Dams across the Nile!
Fleets of Ocean Greyhounds!
Majestic self-amortizing canals!
Plantations of ripening tea
All from tuppence, prudently, thriftily, frugally
Invested ..."

[ken melvin]

Go figure: When the Soviet Union collapsed, they gave the worthless government held assets to the connected turning these connected into billionaires.

[oops]

not to mention the 5% treasury earns on the bank preffered. they can issue paper to pay for it cheaper. as long as the banks don't go under it finances itself.

[robertdfeinman]

To quote the master: "In the long run we are all dead."

There is a short term crisis of liquidity or confidence or whatever you want to call it. How much, and on what, the government spends during this period has a profound effect on how quickly things return to "normal". Right now it seems as if much of this spending is not being effective.

The government may get its money "back" at some point in the future, but the only result of this will be a (slight) decline in some future budget deficit - so what.

I'm still predicting runaway inflation at some point in the not to distant future. The temptation to devalue existing debt obligations by governments has always been irresistible, and I don't see why it should be different this time. We have yet to raise a single penny in taxes to pay for the current wars. This was the same policy practiced during the Vietnam war and the results were the stagflation of the 1970's.

What has changed that a similar thing won't happen this time? So the government will get its money "back" in the future, but it will be with inflated dollars. The books will look good, but will any of the fundamental problems of our society have been solved? Will we see a better social safety net? Will our infrastructure and competitiveness have been restored? Will we have solved the problems of resource shortages and climate change? Will the rich be any less powerful and will representative democracy be more representative?

I don't see anything in the current discussions that would give any hope along any of these fronts.

[Massimo GIANNINI]

As long as they are just Throwing numbers

["investor"]

I want in on these great "investments" the government is making. The government is an excellent "investor" in financial markets. They will make us all rich!

How can I give the government my money so that they will "invest" my money in good "investments"? They are already making great "investments"! I want in on the action to score great returns on future government "investments".

[ctindale]

Well buying back all those stadiums (and there are allot of them) is going to suck up allot of future income, so the governments buying old assets of folks in the hope of selling them back to the same folk they bought them off . Meanwhile how do we expect these assets to perform ? Are folks going to manage these assets so they get the best out of them or are they going to put their hand up for the government to buy them. If you offer $7 trillion how much of it is taken up ? Is there a moral hazard somewhere here?

How does this effect malinvestment, do folks now much wiser after the Fed saved them from the outcome of their poor stadium purchase go build another stadium down the road on the expectation they can sell it to the fed again at some later date....... or do stadium entrepreneurs magically turn over a new leaf and build a factory so they can sell stuff back to the Chinese?

So folks are borrowing money off the Chinese to build stadiums, then the government borrows money off the Chinese to buy that stadium back and at some point future Used Stadium Entrepreneurs borrow again to buy the stadium off the government?

So we have washed away the threat of creative destruction , we disallowed the business cycle as it appears to destructive for our appetite , we have re aligned all toward endlessly expanding debt and consumption for its own sake, we have brushed our children's welfare aside , to what end? for what purpose?

What if there is an upper limit to combined public and private debt? , a ceiling over which economic expansion is hindered rather than fostered, does massive debt expansion really in the long run overcome debt deflation . Can it really compared to Japan in the 90s, did they have a trade surplus, a debt to income ratio of half the current US situation, were they not savers?

[Danny L. McDaniel]

Most Americans should first understand double-entry bookkeeping: When you bailout someone you hurt someone else. A bailout is the financial world's equal to steriods; they give the appearence of diligents and hard work but are not real, and have crippling effects later on.

Danny L. McDaniel
Lafayette, Indiana