global banking

Washington University Law Review

Volume 88 | Issue 1

2010

Measuring the True Cost of Government Bailout Cheryl D. Block

Follow this and additional works at: https://openscholarship.wustl.edu/law_lawreview

Part of the Banking and Finance Law Commons, and the Consumer Protection Law Commons

This Article is brought to you for free and open access by the Law School at Washington University Open Scholarship. It has been accepted for inclusion in Washington University Law Review by an authorized administrator of Washington University Open Scholarship. For more information, please contact [email protected].

Recommended Citation Cheryl D. Block, Measuring the True Cost of Government Bailout, 88 Wash. U. L. Rev. 149 (2010). Available at: https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

149

MEASURING THE TRUE COST OF

GOVERNMENT BAILOUT

CHERYL D. BLOCK 

Government intervention to assist individual businesses and industries

during the 2008–2009 economic crisis was extraordinary in variety and

scope. Despite official protestations of ―no more bailout‖ in the Dodd-

Frank Wall Street Reform and Consumer Protection Act of 2010, future

government interventions are inevitable, should economic circumstances

become sufficiently dire. Moreover, even if Congress eliminates overt

bailout-type interventions, indirect forms of public bailout are likely to

continue. Understandably, taxpayers have been concerned about the cost.

A simple tally of dollars authorized or disbursed is wholly inadequate to

accurately assess the costs of various interventions. This Article addresses

the challenges of providing reasonable budgetary information with respect

to different types of bailout expenditures. In addition to looking at costs

for the more obvious bailout programs, the analysis explores the special

cost estimation challenges for other more covert actions, such as special

tax breaks or relief from burdensome regulation, that serve a "bailout"

function. The Article also takes issue with the fragmentation of

intervention efforts among different ―on-budget‖ and ―off-budget‖ entities

and with some of the methodologies used by the government to value

assets obtained in its bailout efforts, arguing that decision making about

the appropriate allocation of aggregate resources is hampered when some

expenditures are ―off-budget‖ altogether and when even ―on-budget‖

agencies use different accounting methods. Finally, the Article calls for

transparency and budget accounting for public bailouts accomplished

more indirectly through the tax system and other regulatory regimes.

Adequate and transparent budget accounting for bailout costs requires

greater consistency in valuation and accounting methods, and a more

unified presentation of aggregate information in the budget with respect to

all government bailout-type activities.

 Professor of Law, Washington University in St. Louis School of Law. I would like to thank

Dean Kent Syverud and the Washington University in St. Louis School of Law for generous research support. Thanks also to Rebecca Kysar and other participants at the Brooklyn Law School Faculty

Workshop series, and to participants in the 2009 Federal Budget and Tax Policy for a Sound Fiscal

Future interdisciplinary conference at the Washington University in St. Louis School of Law. Finally, my appreciation goes to Dorie Bertram, Washington University Law Library, Director of Public

Services; Judith Stark, Washington University Law Library Documents Librarian; and to my research

assistants, Maria Barbu, Nicholas Bernier, Jonah Brotman, David Hart, Justin Kanter, and Jeanette Stecker.

Washington University Open Scholarship

150 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

I. INTRODUCTION AND BRIEF HISTORY................................................... 152 A. Introduction ............................................................................. 152 B. Brief History of Recent Events ................................................ 156

II. MISCONCEPTIONS ABOUT BAILOUTS AND BAILOUT COSTS .............. 160 A. Bailout v. Stimulus ................................................................... 160

1. Differences in Definition ................................................. 160 2. Differences in Cost Assessment ....................................... 162

B. Classifying Bailout Types by Cost ........................................... 163 1. Profitable Bailouts........................................................... 163 2. Low- or No-Cost Bailouts ................................................ 164 3. Nongeneral Revenue or ―Special Fund‖ Bailouts .......... 165 4. General Revenue Bailouts ............................................... 168 5. Combination Bailouts ...................................................... 169

III. BAILOUT COSTS: WHERE IN THE BUDGET? ...................................... 170 A. Introduction ............................................................................. 170 B. The Federal Reserve ................................................................ 172

1. The Federal Reserve and Monetary Policy ..................... 172 2. The Federal Reserve Bank’s Role in Recent Bailout

Activity ............................................................................. 174 3. Expansion of Federal Reserve Activity in Response to

Crisis ............................................................................... 175 4. Budget Implications of Federal Reserve Programs ........ 180

a. The Federal Reserve and Its Balance Sheets ........... 180 b. The Impact of the Federal Reserve Bank’s Actions

on the Federal Budget ............................................. 183 5. Federal Reserve Bank Budget Status and Reporting ....... 185

C. Other ―Off-Budget‖ Bailout Issues ......................................... 189 1. Housing-Related GSEs .................................................... 189 2. Government Takeover of Fannie Mae and Freddie

Mac .................................................................................. 190 3. Budget Implications of the GSE Takeover and Other

Housing-Related Government Interventions ................... 191

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 151

IV. ESTIMATING THE COSTS OF OVERT BAILOUTS ................................. 196 A. Introduction: Budget Accounting for Contingent Risks and

Uncertain Valuations .............................................................. 196 B. Direct Loans, Loan Guarantees, and Other Contingent

Liabilities ................................................................................. 197 1. Federal Government Loan and Insurance Programs ...... 197 2. Cash v. Accrual Accounting for Loans and Other

Credit Programs .............................................................. 198 3. TARP, Credit Reform, and Asset Valuation .................... 201 4. Mission Fragmentation ................................................... 204

V. ESTIMATING THE COSTS OF COVERT OR HIDDEN BAILOUTS ............. 206 A. Relief Through Tax Expenditures ............................................ 206

1. In General ........................................................................ 206 2. Net Operating Loss (NOL) Carryovers: Internal

Revenue Code § 172 ........................................................ 207 3. Loss Limitations Following Corporate Ownership

Changes: Internal Revenue Code § 382 .......................... 209 4. Reporting Ordinary Losses From Fannie Mae and

Freddie Mac Stock Sales ................................................. 210 5. Budgetary Concerns ........................................................ 211

B. Relief Through Tax Administration and Regulations .............. 212 1. Bailout Through Relaxed Agency Interpretation of Tax

Provisions ........................................................................ 212 2. IRS Interpretive Authority and the Administrative

Procedure Act .................................................................. 213 3. Cost-Benefit Analysis and the IRS ................................... 215 4. A Case Study of Hidden Bailout and the Need for Cost-

Benefit Analysis ............................................................... 216 a. Relaxed IRS Loss Restriction Rule Interpretations.. 216 b. Estimating the Costs and Lessons From Notice

2008-83 .................................................................... 221 c. Notice 2008-83 and Budget Scoring ........................ 222

C. Other Hidden Bailout Costs .................................................... 223 1. Nontax Regulatory Relief ................................................ 223 2. Moral Hazard and Implicit Guarantees .......................... 224

VI. WALL STREET REFORM ACT—A POSTCRIPT ................................... 225 VII. CONCLUSION .................................................................................... 227

Washington University Open Scholarship

152 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

I. INTRODUCTION AND BRIEF HISTORY

A. 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

1. Press Release, Am. Dialect Soc‘y, ―Bailout‖ Voted 2008 Word of the Year by American

Dialect Society (Jan. 9, 2009), available at http://www.americandialect.org/2008-Word-of-the-Year-

PRESS-RELEASE.pdf. 2. After meeting by conference call on November 28, 2008, the National Bureau of Economic

Research (NBER), a private, nonprofit, nonpartisan research organization, officially declared that the

domestic economy had been in recession since December 2007. NAT‘L BUREAU OF ECON. RESEARCH, DETERMINATION OF THE DECEMBER 2007 PEAK IN ECONOMIC ACTIVITY (2008), available at

http://www.nber.org/dec2008.pdf. According to the NBER, ―[a] recession is a significant decline in

economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.‖ NAT‘L BUREAU OF

ECON. RESEARCH, THE NBER‘S RECESSION DATING PROCEDURE (2003), available at http://www.

nber.org/cycles/recessions.html. By conference call on September 19, 2010, the NBER officially

determined that the recession ended in June 2009 and declared it the longest of any recession since

World War II. NAT‘L BUREAU OF ECON. RESEARCH, BUSINESS CYCLE DATING COMMITTEE (2010),

available at http://www.nber.org/cycles/sept2010.html. 3. Chrysler Corporation Loan Guarantee Act of 1979, Pub. L. No. 96-185, 93 Stat. 1324 (1980).

4. Emergency Loan Guarantee Act, Pub. L. No. 92-70, 85 Stat. 178 (1971). Although this Act

was general in scope, its passage was motivated by the financial problems of the Lockheed Aircraft Corporation. H.R. REP. NO. 92-379, at 1272 (1971).

5. New York City Loan Guarantee Act of 1978, Pub. L. No. 95-339, 92 Stat. 460; New York

City Seasonal Financing Act of 1975, Pub. L. No. 94-143, 89 Stat. 797. 6. See, e.g., The Emergency Rail Services Act of 1970, Pub. L. No. 91-663, 84 Stat. 1975

(providing federal loan guarantees to bankrupt railroads); Regional Rail Reorganization Act of 1973,

Pub. L. No. 93-236, § 301, 87 Stat. 985, 1004 (1974) (creating Conrail as a private, government- sponsored corporation to provide railroad services); see also Reg‘l Reorganization Act Cases, 419 U.S.

102 (1974) (upholding constitutionality of the Regional Rail Reorganization Act of 1973); Id. at 109 n.3 (listing individual bankrupt railroads); Henry H. Perritt, Jr., Ask and Ye Shall Receive: The

Legislative Responses to the Northeast Rail Crisis, 28 VILL. L. REV. 271 (1983).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 153

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

7. Air Transportation Safety and System Stabilization Act, Pub. L. No. 107-42, 115 Stat. 230

(2001); see also Margaret M. Blair, The Economics of Post-September 11 Financial Aid to Airlines, 36

IND. L. REV. 367 (2003); Tara Branum & Susanna Dokupil, Security Takeovers and Bailouts: Aviation and the Return of Big Government, 6 TEX. REV. L. & POL. 431 (2002).

8. Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73,

103 Stat. 183; see also BAIRD WEBEL, N. ERIC WEISS & MARC LABONTE, CONG. RESEARCH SERV., RS22956, THE COST OF GOVERNMENT FINANCIAL INTERVENTIONS, PAST AND PRESENT 6 (2008)

(reporting a $150 billion final cost to the Treasury Department for the savings and loan bailouts).

9. Media coverage of congressional financial regulatory reform debates often referred to public

anger over bailouts, Wall Street, and government regulators. See, e.g., Jackie Calmes, Democrats Seize

on Oversight, WASH. POST, Apr. 19, 2010, at A1 (referring to increased confidence among Democrats

about prospects for financial regulatory reform given ―voter anger at big banks and bailouts‖); Jim Puzzanghera, Debate Begins on Final Overhaul Reform, CHI. TRIB., June 11, 2010, at C31 (quoting

Rep. Paul Kanjorski as saying, ―[f]eelings of anger, frustration and rage justifiably hang over this

proceeding because of the recklessness of financial whiz kids, the greediness of Wall Street bankers and the shortsightedness of our economic regulators‖).

10. Pub. L. No. 111-203, 124 Stat. 1376. Congress‘s recent passage of this Act was a remarkable

political and policy achievement, which—among many other things—provided new consumer protections, id. tit. X, and reforms to increase Wall Street transparency and accountability, id. tit. VII.

The Act was signed into law just as this Article entered final editing. The voluminous Act covers many

areas that are beyond the scope of this Article. Aspects of the legislation that are significant to the discussion are considered briefly throughout the Article. See also discussion infra Part VI.

11. Id. (preamble).

12. Id. tit. II, § 204(a). The legislation provides detailed procedures for making a formal ―systemic risk determination,‖ id. § 203, and a court order appointing the Federal Deposit Insurance

Corporation (FDIC) as receiver. Id. § 202.

Washington University Open Scholarship

154 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

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

13. Id. § 210(n) (establishing an ―Orderly Liquidation Fund‖). 14. Id. § 210(n)(5).

15. Id. § 210(o) (providing for risk-based assessments on bank holding companies with total

consolidated assets equal to or greater than $50 billion and on certain nonbank financial companies). 16. Id. § 214(c).

17. Remarks on Signing the Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010

DAILY COMP. PRES. DOC. 617 (July 21, 2010) (emphasis added). 18. See infra notes 24–25, 89–94, 175–82 and accompanying text.

19. For similar observations, see Adam J. Levitin, In Defense of Bailouts, 99 GEO. L.J.

(forthcoming 2011) (manuscript at 4–5), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 155

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

id=1548787 (―Bailouts are an inevitable feature of modern economies, where the interconnectedness

of firms means that the entire economy bears the risk of individual firms‘ failure. . . . Any prefixed resolution regime will be abandoned whenever it cannot provide acceptable distributional outcome. In

such cases, bailouts are inevitable.‖).

20. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, §§ 204, 205, 124 Stat. 1376, 1454–58.

21. DOUGLAS J. ELLIOTT, BROOKINGS INST., MEASURING THE COST OF THE TARP 7 (2009).

Washington University Open Scholarship

156 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

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 working

definition does not include government assistance to individuals facing

economic distress. Although there certainly are overlaps in the types of

budgetary issues raised in the business and personal settings, my focus is

on government intervention to assist financial or business entities.

B. Brief History of Recent Events

Public awareness of the recent downward economic spiral perhaps

became most widespread in March 2008, with dramatic reports of

emergency meetings at which the then Treasury secretary Henry Paulson,

Federal Reserve Board Chairman Ben Bernanke, and other officials

assisted in brokering J.P. Morgan‘s acquisition of Bear Stearnsa deal

that would not have closed without the New York Federal Reserve‘s

guarantee to absorb $29 billion in losses on Bear Stearns‘ riskiest assets. 23

In July 2008, as housing and financial markets declined, the Treasury

Department successfully sought congressional authority to seize control of

troubled mortgage finance giants Fannie Mae and Freddie Mac. 24

By

September 2008, the federal government held Fannie Mae and Freddie

Mac in conservatorship and had itself become a preferred shareholder. 25

At

22. Cheryl D. Block, Overt and Covert Bailouts: Developing a Public Bailout Policy, 67 IND.

L.J. 951, 960 (1992) [hereinafter Block, Bailouts]. 23. Details of the transaction were reported by the Federal Reserve in Legal Developments:

Second Quarter, 2008, FED. RES. BULL., Aug. 2008, at 73, 78–81; see also GARY SHORTER, CONG.

RESEARCH SERV., RL34420, BEAR STEARNS: CRISIS AND ―RESCUE‖ FOR A MAJOR PROVIDER OF MORTGAGE-RELATED PRODUCTS (2008). For Treasury Secretary Paulson‘s personal perspective, see

HENRY M. PAULSON, JR., ON THE BRINK: INSIDE THE RACE TO STOP THE COLLAPSE OF THE GLOBAL

FINANCIAL SYSTEM 90–121 (2010). 24. Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, § 1117, 122 Stat. 2654,

2683–88.

25. Press Release, U.S. Dep‘t of the Treasury, Statement by Secretary Henry M. Paulson, Jr., on Treasury and Federal Housing Finance Agency Action to Protect Financial Markets and Taxpayers

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 157

about the same time, the Federal Reserve authorized a loan of up to $85

billion to stave off the imminent collapse of American International Group

(AIG), the nation‘s largest insurance company, and took warrants that, if

converted into common stock, would give the government an

approximately 80% equity interest in the insurance giant. 26

Shortly

thereafter, the Federal Reserve expanded its assistance to AIG, authorizing

a cash infusion of up to an additional $37.8 billion, in exchange for AIG

securities through a newly created Securities Borrowing Facility (SBF)

and another $14 billion through another new facility, the Commercial

Paper Funding Facility (CPFF). 27

Further assistance followed when the

Federal Reserve created special entities, referred to as ―special purpose

vehicles‖ or SPVs, for the sole purpose of acquiring AIG troubled assets. 28

By late September 2008, it had become clear to members of both

parties that more systemic intervention was needed. In response to the

Treasury Department‘s request for greater authority, Congress enacted the

Emergency Economic Stabilization Act of 2008 (EESA), 29

creating a new

Troubled Asset Relief Program (TARP), 30

which quickly became

popularly referred to as the ―$700 billion bailout.‖ 31

In addition to direct

(Sept. 7, 2008), available at http://ustreas.gov/press/releases/hp1129.htm; see also N. ERIC WEISS, CONG. RESEARCH SERV., RL34661, FANNIE MAE‘S AND FREDDIE MAC‘S FINANCIAL PROBLEMS:

FREQUENTLY ASKED QUESTIONS (2008). For further discussion of the Fannie Mae and Freddie Mac

takeover and its budget implications, see infra notes 182–88 and accompanying text. 26. For a detailed description of the Federal Reserve Loan to AIG, see BAIRD WEBEL, CONG.

RESEARCH SERV., R40438, ONGOING GOVERNMENT ASSISTANCE FOR AMERICAN INTERNATIONAL

GROUP (AIG) (2009); Press Release, Bd. of Governors of the Fed. Reserve Sys. (Sept. 16, 2008). 27. BAIRD WEBEL, CONG. RESEARCH SERV., R40438, ONGOING GOVERNMENT ASSISTANCE FOR

AMERICAN INTERNATIONAL GROUP (AIG) 5 (2009). Provisions in the 2010 Wall Street Reform Act

create a new loan guarantee program to provide emergency financial stability to solvent depository institutions, but the guarantee ―may not include the provision of equity in any form.‖ Dodd-Frank Wall

Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, § 1105, 124 Stat. 1376,

2121–25. 28. BAIRD WEBEL, CONG. RESEARCH SERV., R40438, ONGOING GOVERNMENT ASSISTANCE FOR

AMERICAN INTERNATIONAL GROUP (AIG) 7–8 (2009).

29. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, 122 Stat. 3765 (to be codified at 12 U.S.C. §§ 5201–5261).

30. Id. tit. I, §§ 101–136 (to be codified at 12 U.S.C. §§ 5211–5241). Originally scheduled to

expire on December 31, 2009, TARP was extended through October 3, 2010, pursuant to EESA authority granted to the Treasury Secretary. Id. § 120(b). See also Press Release, U.S. Dep‘t of the

Treasury, Treasury Department Releases Text of Letter from Secretary Geithner to Hill Leadership on

Administration‘s Exit Strategy for TARP (Dec. 9, 2009), available at http://financialstability.gov/latest /pr_12092009. html.

31. EESA authorized the Treasury Department to establish an Office of Financial Stability (OFS)

to purchase troubled assets using three ―tranches‖ of funding totaling $700 billion. Emergency Economic Stabilization Act of 2008 §§ 101(a), 115(a). The $700 billion total authority was

subsequently reduced by $1.24 billion to offset the costs of program changes. See Helping Families

Save Their Homes Act of 2009, Pub. L. No. 111-22, § 202(b), 123 Stat. 1632, 1643. TARP authority

Washington University Open Scholarship

158 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

assistance from the Federal Reserve, AIG also benefitted from the TARP

program, through which the Treasury Department purchased $40 billion in

preferred AIG stock and extended a $30 billion line of credit. 32

The economic crisis was not limited to financial industries. Faced with

a twenty-six-year low in sales, automobile industry executives lobbied

heavily in September 2008 for $25 billion in immediate direct federal

loans. 33

When Congress failed to authorize loans through the 2007 Energy

Independence and Security Act (EISA), 34

the Bush administration instead

assisted the auto industry through a new Automotive Industry Financing

Program (AIFP) created under the TARP umbrella. 35

A concerned public began tallying the remarkable bailout costs to the

taxpayer: a $700 billion TARP program, $29 billion in financing for the

Bear Stearns acquisition, $85 billion and counting to AIG, and still more

for the automobile industry. 36

As the saying goes, add all this together and,

pretty soon, you‘re talking about real money. Some headlines declared,

―Total Bailout Cost Heads Towards $5 Trillion.‖ 37

Others placed the

was later further reduced to $475 billion. Dodd-Frank Wall Street Reform and Consumer Protection

Act of 2010 § 1302. 32. See CONG. BUDGET OFFICE, THE BUDGET AND ECONOMIC OUTLOOK: FISCAL YEARS 2010

TO 2020, at 12–13 (2010); see also U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO-09-975, TROUBLED

ASSET RELIEF PROGRAM: STATUS OF GOVERNMENT ASSISTANCE PROVIDED TO AIG (2009). 33. STEPHEN COONEY ET AL., CONG. RESEARCH SERV., R40003, U.S. MOTOR VEHICLE

INDUSTRY: FEDERAL FINANCIAL ASSISTANCE AND RESTRUCTURING 1 (2009); Frank Ahrens, Ailing

Auto Industry Sends in Its Pitchman: CEO of GM Leads Lobby of Lawmakers for Loans, WASH. POST, Sept. 12, 2008, at D1.

34. Energy Independence and Security Act of 2007, Pub. L. No. 110-140, § 136, 121 Stat. 1492,

1514–16. Explaining and describing the Energy Independence Act, as amended, the House Agriculture Committee reported that the act‘s loan and loan guarantee programs were designed to assist auto

manufacturers with the costs of acquiring fuel-efficient parts and developing advanced vehicle

technology systems. H.R. REP. NO. 110-933, at 42–44 (2009). As one report stated, ―[t]his program has been widely misinterpreted as a broad ‗bailout‘ . . . [but] the language in these laws indicates the

intent of Congress that the loans are for the purpose of enabling the U.S. auto industry to produce more

fuel-efficient vehicles.‖ STEPHEN COONEY & BRENT D. YACOBUCCI, CONG. RESEARCH SERV., RL34743, FEDERAL LOANS TO THE AUTO INDUSTRY UNDER THE ENERGY INDEPENDENCE AND

SECURITY ACT 1 (2008). Congress rejected use of EISA funds for the auto industry bailout. Auto

Industry Financing and Restructuring Act, H.R. 7321, 110th Cong. (2d Sess. 2008) (passed by the House, but never adopted by the Senate).

35. As described by the OFS, the objective of the Automotive Industry Financing Program was

―to help prevent a significant disruption of the American automotive industry, which would have posed a systemic risk to financial market stability and had a negative effect on the economy.‖ OFFICE

OF FIN. STABILITY, U.S. DEP‘T OF THE TREASURY, AGENCY FINANCIAL REPORT: FISCAL YEAR 2009,

at 33 (2009); see also CONG. OVERSIGHT PANEL, SEPTEMBER OVERSIGHT REPORT: THE USE OF TARP FUNDS IN THE SUPPORT AND REORGANIZATION OF THE DOMESTIC AUTOMOTIVE INDUSTRY 6 (2009)

(reporting the broadening of TARP activities). 36. Costs of loans and other types of financial assistance to the auto makers are incorporated in

TARP totals.

37. See Steve Watson, Total Bailout Cost Heads Towards $5 TRILLION, INFOWARS.NET (Oct.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 159

figure at more than $7 trillion. 38

Some reporters dramatically estimated the

―per taxpayer‖ costs. One such report calculated the total bailout cost as

$61,871 per taxpayer. 39

And, these early estimates do not include the $787

billion stimulus legislation later passed by Congress and signed into law

by President Obama in February 2009. 40

A simple tally of dollars authorized or disbursed, of course, is wholly

inadequate to accurately assess the ultimate taxpayer cost of government

bailouts. In some cases, the intervention simply authorized the government

to take specified actions, as needed, at a later date. At least initially, the

$700 billion bailout fell into this category, as the legislation did not

provide immediate authority for access to funds. Upon enactment of

TARP, the Treasury Secretary was authorized to purchase up to $250

billion of troubled assets. 41

This authorization was increased to $350 if the

President certified to Congress the need to purchase additional troubled

assets, 42

with the remaining funds to be released upon the President‘s

submission of a detailed written plan to Congress. 43

In the end, although

Presidents Bush and Obama requested authorization for release of the full

$700 billion, ―improved financial conditions and careful stewardship of

the program‖ led the Treasury Department to announce in December 2009

that it did not expect to use more than $550 billion in TARP funds ―unless

necessary to respond to an immediate and substantial threat to the

economy stemming from financial instability.‖ 44

At the end of the day, the actual long-term cost for TARP and other

bailout-type disbursements will vary dramatically, depending upon

particular use of the funds. Different types of government assistance will

require different cost estimation methodologies. Government purchase of

troubled assets, for example, may have a very different short- and long-

15, 2008), http://www.infowars.net/articles/october2008/151008Bailout_figures.htm.

38. David Goldman, Bailouts: $7 Trillion and Rising; CNNMONEY.COM (Nov. 28, 2008), http://

money.cnn.com/2008/11/26/news/economy/where_bailout_stands/index.htm. 39. See Alexis Leondis, Tallying Trillions in Bailout, Bankruptcy: Commentary, BLOOMBERG

(Dec. 31, 2008), http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aYwo1tZqGFgA.

40. American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, 123 Stat. 115. 41. 12 U.S.C. § 5225(a)(1) (2006).

42. 12 U.S.C. § 5225(a)(2) (2006). President Bush subsequently certified the need for release of

the second ―tranche‖ of funds. Letter from George W. Bush, U.S. President, to U.S. Congress (Jan. 12, 2009), available at http://financialservices.house.gov/TARP011209.pdf.

43. 12 U.S.C. § 5225(a)(3) (2006). President-elect Obama‘s administration subsequently

submitted the required plan to Congress for release of the third ―tranche.‖ Letter from Lawrence Summers, Dir.-designate, Nat‘l Econ. Council, to the leaders of the U.S. House of Representatives &

U.S. Senate (Jan. 12, 2009) available at http://www.cbsnews.com/htdocs/pdf/011209_summers.pdf?

tag=contentMain;contentBody. 44. Press Release, Dep‘t of the U.S. Treasury, supra note 30.

Washington University Open Scholarship

160 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

term budgetary impact than extensions of direct loans or loan guarantees.

In fact, government loan guarantees involve no immediate release of

funds, yet may impose significant long-term costs. Government

intervention may also take the form of special tax breaks or relief from

burdensome regulatory obligations. 45

As difficult as it may be to measure

the costs of overt bailouts, assessing the costs of these more subtle or

hidden government actions that may serve a bailout function will present

even greater challenges.

II. MISCONCEPTIONS ABOUT BAILOUTS AND BAILOUT COSTS

A. Bailout v. Stimulus

1. Differences in Definition

Reports of government responses to economic turmoil often loosely

use the terms ―bailout‖ and ―stimulus,‖ suggesting, perhaps, that the two

are synonymous. Although the definitional boundary can be fuzzy in some

cases, government bailout-type actions differ from government stimulus

efforts along a number of different dimensions. Along the temporal

dimension, bailouts generally are immediate, emergency efforts to prevent

imminent collapse, or backward-looking attempts to rescue private entities

from economic damage that has already occurred. Stimulus, on the other

hand, tends to be forward looking, designed to spark economic growth or

redevelopment.

Such stimulus legislation may come in a number of different flavors.

Even in times of reasonable economic health, Congress may enact

stimulus legislation simply to spur general economic growth. For instance,

Congress adopted the Accelerated Cost Recovery System (ACRS) of

depreciation to allow more rapid write-offs of certain business expenses,

thus stimulating economic investment. 46

Stimulus legislation also may be

passed in advance of potential economic decline in an effort to prevent

future crisis, rather than to provide assistance at a moment of immediate

crisis. In the alternative, stimulus legislation may be enacted immediately

after a crisis to spur economic redevelopment of areas hard hit by

45. See discussion infra notes 262–72, 306–23, 328–32 and accompanying text. 46. See STAFF OF THE JOINT COMM. ON TAXATION, 97TH CONG., GENERAL EXPLANATION OF

THE ECONOMIC RECOVERY TAX ACT OF 1981, at 75 (Comm. Print 1981) (―The Congress concluded

that prior law rules for determining depreciation allowances and the investment tax credit needed to be replaced because they did not provide the investment stimulus that was felt to be essential for

economic expansion.‖).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 161

economic or natural disaster. For example, Congress created special ―New

York Liberty Zones‖ to spur investment in lower Manhattan following the

collapse of the World Trade Towers 47

and special ―Gulf Opportunity

Zones‖ to spur investment in areas of the Gulf Coast affected by the

devastating 2005 hurricane season. 48

These stimulus provisions are distinct

from other relief efforts designed to offer more immediate assistance to

disaster victims.

In scope, bailout tends to be narrower than stimulus. Congress might

provide general economic stimulus, for example, through broad-based tax

rate cuts. On the other hand, it is hard to imagine describing any

government action as a ―general economic bailout.‖ At the other end of a

continuum, bailout-type government actions may be specific to a

particular business entity in a way that stimulus is not. It makes sense, for

instance, to refer to ―bailing out,‖ but not to ―providing a stimulus for,‖ the

Chrysler corporation. Between the general economy and firm-specific

extremes, the distinction between bailout and stimulus can be fuzzier.

Both stimulus and bailout efforts can be focused on particular industries

such as savings and loan institutions, banks, airlines, or automotive

manufacturers. One recent stimulus that some might think of as a bailout

was the so-called ―Cash for Clunkers‖ program, which, for a short time,

offered government cash rebates to consumers when they traded an old

vehicle upon purchase of a new, more fuel-efficient one. 49

A substantial

factor motivating this legislation surely was the desire to provide

assistance to small car dealerships, which had been experiencing an

increasing number of bankruptcies. 50

Since the legislation incorporated

47. This special zone was defined to include only specified portions of lower Manhattan: ―the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or

Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan in the City of

New York, New York.‖ Job Creation and Worker Assistance Act of 2002, Pub. L. No. 107-147 § 301(h), 116 Stat. 21, 39 (codified at 26 U.S.C. § 1400L(h) (2006)).

48. A ―Gulf Opportunity Zone,‖ or ―GO Zone,‖ includes ―that portion of the Hurricane Katrina

disaster area determined by the President to warrant individual or individual and public assistance from the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance

Act by reason of Hurricane Katrina.‖ Gulf Opportunity Zone Act of 2005, Pub. L. No. 109-135,

§ 101(a), 119 Stat. 2577, 2578 (codified at 26 U.S.C. § 1400M(1) (2006)). 49. Consumer Assistance to Recycle and Save Act of 2009, Pub. L. No. 111-32, tit. XIII, 123

Stat. 1859, 1909.

50. Although the legislation, on its surface, was a stimulus and environmental measure, several legislators and members of the press saw it as just another auto industry bailout. See, e.g., 155 CONG.

REC. S8955 (daily ed. Aug. 6, 2009) (statement of Sen. Richard Shelby) (―The Cash for Clunkers

Program is simply another bailout to prop up a struggling industry wrapped in the political guise of an environmentally friendly program.‖); 155 CONG. REC. S6790 (daily ed. June 18, 2009) (statement of

Sen. John McCain regarding ―Cash for Clunkers‖) (―We now own two automotive companies . . . Why

do we need another bailout for the auto industry?‖); Dan Becker & James Gersenzang, Cash for

Washington University Open Scholarship

162 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

stimulus features—and as bailout was becoming an increasingly pejorative

term—it was probably more politically expedient to sell this legislation as

stimulus.

Perhaps the most important features often distinguishing bailouts and

stimulus are policy goals and institutional design. Bailouts tend to offer

immediate infusions of government funds through direct or guaranteed

loans, or government purchase of debt or equity instruments. In contrast,

stimulus legislation is generally designed to provide incentives for

businesses or individuals to engage in particular desired behaviors. Most

often, the goal is to stimulate investment, either generally or in specific

types of assets or investments. 51

The institutional design most frequently

adopted in stimulus legislation is a special tax deduction or credit. 52

2. Differences in Cost Assessment

At the margins, one might debate whether a particular piece of

legislation represents bailout or stimulus. For purposes of this Article,

however, the key question is whether there is any budgetary difference in

measuring the costs imposed by bailout as opposed to stimulus legislation.

Since bailouts generally involve immediate expenditures, it might appear

that bailout costs are easier to measure than stimulus costs. However,

simply tallying total disbursements on a cash-flow basis will not provide

an accurate picture of the long-term costs of bailouts. Some government

loans will be repaid, but others will not. Although one cannot know in

advance the precise percentage of businesses that will ultimately default,

economists have developed sophisticated, risk-based models that permit

reasonable estimation of long-term credit program costs. 53

Budget rules

enacted in 1990 require the use of accrual, rather than cash-method,

accounting for federal credit programs. 54

Clunkers is Bait and Switch, WASH. POST, May 17, 2009, at A35 (―The automakers are filling up again at the Capitol Hill bailout pump. The latest idea is ‗cash for clunkers.‘‖).

51. Stimulus provisions may also be designed to encourage employers to hire or retain workers.

See, e.g., Hiring Incentives to Restore Employment Act, Pub. L. No. 111-147, § 102, 124 Stat. 71, 75 (2010) (Business Credit for Retention of Certain Newly Hired Individuals in 2010).

52. Id.; see also id. § 201 (Increase in Expensing of Certain Depreciable Business Assets).

53. Although the federal government generally uses a Treasury market rate to calculate the net present value of assets, the EESA actually requires use of a risk-based rate for purposes of computing

the value of TARP assets held by the government. Emergency Economic Stabilization Act of 2008,

Pub. L. No. 110-343, 122 Stat. 3765 (to be codified at 12 U.S.C. §§ 5201–5261); see discussion infra notes 233–44 and accompanying text.

54. Federal Credit Reform Act of 1990, Pub. L. No. 101-508, § 13201(a), 104 Stat. 1388, 1388-

609 (codified at 2 U.S.C. § 661 (2006)). For further discussion of cash versus accrual accounting methods, see infra notes 219–32 and accompanying text.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 163

By institutional design, stimulus legislation relies heavily on incentives

to taxpayers, provided through special tax deductions and credits. The

total actual cost of such legislation to the government, in terms of revenue

foregone, will depend upon how much taxpayers choose to use the

incentives. To some, this is the beauty of tax incentives: taxpayers

effectively ―vote‖ on how much will be spent by either taking advantage

of the incentive or not. Difficulties in determining in advance the extent to

which taxpayers will take advantage of particular incentives make long-

term budgeting for such incentives difficult. It might appear that stimulus

costs for any given year are reasonably simple to measure by summing the

total deductions or credits actually taken on filed tax returns. Here too,

however, a simple tally will not provide an accurate assessment. Some

taxpayers would have engaged in the desired behavior in any event. In

such cases, taxpayers get a windfall, and the government has made a

needless expenditure, paying taxpayers to do something they would have

done anyway. To determine the real stimulus budget cost and the amount

overpaid, one would need to segregate deductions taken by those who

were truly motivated by the tax incentive to engage in the desired activity

from those who would have engaged in the activity in any event. To my

knowledge, there are no strong empirical research models to measure this

windfall effect.

B. Classifying Bailout Types by Cost

1. Profitable Bailouts

Government bailouts that provide genuine assistance to troubled

enterprises do not necessarily involve expenditures of general tax revenue.

In some instances, the government might even profit. As the direct loan

transaction was structured in the Chrysler bailout in the late 1980s, for

example, most or all federal administrative costs were covered by interest

and fees, and with the loans repaid in full, 55

the government reaped an

approximately $300 million profit from the sale of warrants it had taken to

55. 129 CONG. REC. 19,286 (1983) (statement of Sen. Carl Levin) (―I want to commend the Chrysler Corp.‘s decision to repay the remaining $800 million of federally guaranteed debt . . . 7 years

ahead of schedule. . . . Chrysler‘s success was made possible by passage of the Chrysler Loan

Guarantee Act of 1979, which allowed the company to borrow up to $1.2 billion backed by federal guarantees.‖).

Washington University Open Scholarship

164 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

secure its risk. 56

Similar warrants taken as collateral for direct loans to

Lockheed generated a $31 million profit for the federal government. 57

The overall budgetary impact of the 2008–2009 government bailout

activity is likely to be an increased deficit. As of the end of fiscal year

2009, however, the Treasury Department Office of Financial Stability

(OFS) reported $19.5 billion in net income or profit—primarily from

interest, dividends, fees, and warrant repurchases—from four of its

―bailout‖ programs. 58

OFS also reported both that it had spent less TARP

money than anticipated and received a return higher than expected from its

TARP investments. 59

These two factors, combined with general economic

improvement, resulted in a smaller projected deficit impact from TARP

than previously anticipated. In the end, even though some TARP programs

were profitable, aggregate TARP bailout actions are expected to contribute

$116.8 billion to the federal deficit. 60

2. Low- or No-Cost Bailouts

Although they may not result in profit, many government bailout-type

interventions involve little or no expenditure of general revenue. In some

cases, the government simply may facilitate private-market solutions

without placing any federal resources at risk. In 1998, for example, the

Federal Reserve Bank facilitated meetings to bring private lenders and

investors together to work out a rescue plan for Long Term Capital

Management (LTCM), a major U.S. hedge fund faced with imminent

56. As part of its effort to protect itself from risk, the Treasury Department received warrants to purchase Chrysler stock at $13 per share. As Chrysler recovered financially, the stock value increased

substantially above the warrant price. The government ultimately sold the warrants to the highest

bidder (Chrysler itself) and made a $311.1 million profit. R. REICH & J. DONAHUE, NEW DEALS: THE

CHRYSLER REVIVAL AND THE AMERICAN SYSTEM 254–57 (1985); see also BAIRD WEBEL, N. ERIC

WEISS & MARC LABONTE, CONG. RESEARCH SERV., RS22956, THE COST OF GOVERNMENT

FINANCIAL INTERVENTIONS, PAST AND PRESENT 5 (2008). 57. WEBEL, WEISS & LABONTE, supra note 56, at 6.

58. OFFICE OF FIN. STABILITY, U.S. DEP‘T OF THE TREASURY, AGENCY FINANCIAL REPORT:

FISCAL YEAR 2009, at 13 (2009) (referring to the Capital Purchase, Targeted Investment, and Asset Guarantee Programs and the Consumer and Business Lending Initiative). At the same time, however,

OFS reported net losses of $60.9 billion from assistance to the automotive industry and to insurance

giant AIG. Id. 59. Id. at 3.

60. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 40–41 tbl.4-7 (2010) (discussing a projected TARP deficit impact of $116.8 billion, $224.1 billion lower than the earlier

mid-term budget projection).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 165

collapse. 61

In other cases, the government may place itself at some risk

initially but, ultimately, bear no expense. With federal loan guarantee

programs, for example, the government simply acts as guarantor in the

event that the private borrower covered by the program defaults on

obligations to a nongovernment lender. If administration of the program is

covered by fees and the government guarantee is never called, the

intervention falls into the ―no- or low-cost bailout‖ category. 62

3. Nongeneral Revenue or ―Special Fund‖ Bailouts

Many bailout-type interventions, of course, ultimately do impose real

costs. Understandably, taxpayers are concerned about the burdens such

costs impose upon them. Although many bailout-type programs are funded

through general revenues, bailout intervention need not necessarily impose

a direct burden upon general taxpayers. An alternative approach is to

impose bailout costs on some narrower subset of taxpayers.

Under a benefit theory of taxation, ―an equitable tax system is one

under which each taxpayer contributes in line with the benefits which he

or she receives from public services.‖ 63

In some cases, however, the

benefit approach seems inappropriate. For example, it would be

counterproductive to tax the poor on benefits received in the form of

government-provided food stamps. Thus, modern tax policy generally has

rejected this benefit theory of taxation in favor of one based more on

ability to pay. 64

Nevertheless, ―practical applications of benefit taxation

may be found in specific instances where particular services are provided

on a benefit basis. This may be the case where direct financing is made via

fees, user charges, or tolls.‖ 65

For instance, fuel taxes paid by drivers are

61. STEPHEN H. AXILROD, INSIDE THE FED: MONETARY POLICY AND ITS MANAGEMENT,

MARTIN THROUGH GREENSPAN TO BERNANKE 145–50 (2009) (describing Federal Reserve involvement in efforts to save LTCM). For a colorful report on LTCM‘s rise and fall, see generally

ROGER LOWENSTEIN, WHEN GENIUS FAILED: THE RISE AND FALL OF LONG-TERM CAPITAL

MANAGEMENT (2001). For further discussion of the Federal Reserve‘s role in the LTCM bailout, see id. at 185–218.

62. Government assistance that ultimately results in a profit or no cost to the government should

still be regarded as a bailout because the outcome is a gamble. The government assumes a risk that commercial lenders are unwilling to take based upon standard lending principles. General tax revenues

and substantial taxpayer dollars are at risk in a way that they would not be in a private bailout through

reorganization in bankruptcy. 63. RICHARD A. MUSGRAVE & PEGGY B. MUSGRAVE, PUBLIC FINANCE IN THEORY AND

PRACTICE 219 (5th ed. 1989).

64. See, e.g., HENRY C. SIMONS, PERSONAL INCOME TAXATION: THE DEFINITION OF INCOME AS A PROBLEM OF FISCAL POLICY 3–5 (1938).

65. MUSGRAVE & MUSGRAVE, supra note 63, at 221.

Washington University Open Scholarship

166 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

used to fund highway maintenance and other transportation-related

programs. 66

In this way, the cost of the government service is imposed

more directly upon those who benefit.

At first blush, the bailout setting might not appear well suited to the

benefit approach. To impose costs on those who receive bailout assistance

simply would dig struggling businesses receiving assistance deeper into a

financial hole. On the other hand, the federal deposit insurance system is

structured upon similar benefit-like principles. Among other things, the

FDIC has authority to take receivership interests in failed banks, 67

establish and operate ―bridge banks‖ using the failed banks‘ assets, and

ultimately transfer ownership of the ―bridge banks‖ to new private

owners. 68

Resources to cover bank rescue efforts and depositor insurance

claims come from funds in bank insurance pools collected ex ante through

assessments and contributions from banks participating in the insurance

programs, not from general tax revenues. 69

Participating banks provide the

funding for the government insurance program since they make up the

group or class that stands to benefit from the government program, which

offers reassurance to bank customers and other mechanisms to provide

bank stability. For example, the FDIC maintains a Deposit Insurance Fund

(DIF) available to depositors in the event that one of its insured banks

fails. 70

Even when general tax revenues are not used, government-

facilitated rescues should be regarded as bailouts. In each case, the

government has intervened to provide assistance to a failing private

enterprise. I refer to interventions in this category as ―special fund

bailouts.‖

When insurance pool funds are insufficient, the FDIC has authority to

impose an additional ―systemic risk special assessment‖ and to call for

bank prepayments of future assessments. 71

As a backstop, the FDIC has

authority to borrow up to $100 billion from the Treasury Department and

66. Federal-Aid Highway Act of 1956, Pub. L. No. 84-627, 70 Stat. 374 (establishing the

Highway Trust Fund from gasoline excise taxes); see PAMELA J. JACKSON, CONG. RESEARCH SERV.,

RL30304, THE FEDERAL EXCISE TAX ON GASOLINE AND THE HIGHWAY TRUST FUND: A SHORT HISTORY (2006).

67. 12 U.S.C. § 1819(a) (2006).

68. 12 U.S.C. §§ 1821(m), (n) (2006). 69. 12 U.S.C. § 1817(b) (2006) (FDIC‘s risk-based assessment rules).

70. 12 U.S.C. § 1815(d) (2006). Although the direct beneficiary of this insurance is the

individual depositor, insurance programs also serve a bailout function. See Block, Bailouts, supra note 22, at 973–74.

71. One report described a recently FDIC-imposed $45 billion in prepaid annual assessments as a

―plan financed by the industry to rescue the ailing insurance fund that protects bank depositors,‖ i.e., a bailout of the FDIC itself. Stephen Labaton, Banks to Rescue Depleted F.D.I.C., N.Y. TIMES, Sept. 30,

2009, at A1.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 167

even more in certain emergency circumstances. 72

In the end, of course, if

the FDIC cannot meet its obligations or if additional resources are

necessary to maintain bank stability, there remains an implicit guarantee

that Congress will come to the rescue by authorizing the use of general

revenues. Congress provided such financial supplements, for example,

when insurance pools proved inadequate in the 1980s savings and loan

crisis. 73

In the case of ex ante insurance funds, such as the DIF maintained by

the FDIC, those eligible to benefit from future bailout funding must make

advance contributions to an insurance pool. In contrast, the EESA

legislation enacted in 2008 uses an ex post collection model. If TARP has

a net shortfall at the end of five years from the date of enactment, the

statute requires ―the President . . . [to] submit a legislative proposal that

recoups from the financial industry an amount equal to the shortfall in

order to ensure that the Troubled Asset Relief Program does not add to the

deficit or national debt.‖ 74

Based on this mandate, at least in theory, the

Obama administration proposed a controversial ―financial crisis

responsibility fee‖ on large banks and financial institutions in order to

recoup bailout costs from TARP. 75

This proposal called for a fee on large

financial institutions, even if they already repaid TARP funds received or

received no TARP funds at all. At the same time, some large nonfinancial

entities that received TARP funds would not be required to pay. Needless

to say, financial institutions that generated a profit for the government by

repaying the TARP assistance they received with interest, fees, and

warrants, resented the recoupment proposal. 76

The logic behind the

collection-model special fund bailout approach was that large financial

72. The FDIC‘s borrowing authority was increased from $30 to $100 billion by the Helping

Families Save Their Homes Act of 2009, Pub. L. No. 111-22, § 204(c), 123 Stat. 1632, 1649. The Act also provided temporary authority for borrowing of up to $500 billion upon written recommendation

from the Federal Reserve and Secretary of the Treasury in consultation with the president. Id. (to be

codified at 12 U.S.C. § 1824(a)(3) (2006)). The FDIC insisted that its request for additional borrowing authority was simply prudent planning, given that the banking industry‘s assets had tripled since the

last increase in borrowing authority. Promoting Bank Liquidity and Lending Through Deposit

Insurance, Hope for Homeowners, and Other Enhancements: Hearing Before the H. Comm. on Fin. Servs., 111th Cong. 8–9 (2009) (statement of John F. Bovenzi, Chief Operating Officer, FDIC).

Bovenzi added that the FDIC did not expect to use the money. Id. at 10.

73. Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat. 183.

74. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 134, 122 Stat. 3765,

3798 (to be codified at 12 U.S.C. § 5239) (emphasis added). 75. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 174 (2010).

76. See, e.g., Eric Dash, Wall St. Weighs a Constitutional Challenge to a Proposed Tax, N.Y. TIMES, Jan. 18, 2010, at B1.

Washington University Open Scholarship

168 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

entities—even those that did not participate in TARP—benefitted most

from the governments‘ propping up of failing banks. Assuming that a

much larger systemic financial breakdown would have occurred absent

government intervention, the largest financial firms were those with the

most at stake and, hence, the most to gain from avoidance of a financial

meltdown. In addition, the largest financial institutions are thought to be

those best able to pay.

Congress never enacted the president‘s proposed ―financial crisis

responsibility fee,‖ but the 2010 Wall Street Reform Act did adopt a

benefit-like, ex post ―collection model,‖ permitting the FDICif

necessaryto impose risk-based assessments on bank holding companies

with $50 billion or more in consolidated assets to contribute to a new

―orderly liquidation fund.‖ 77

This technically is not a ―bailout‖ fund since

it is not available to assist or rescue private firms faced with economic

distress or imminent failure, 78

but instead to provide an orderly process for

shutting down failing financial institutions. At the same time, the idea

behind the orderly liquidation process is to save the economy from the

chaos and distress that would otherwise result from the disorderly failure

of a systemically important financial firm. Ideally, the costs of orderly

liquidation will be covered by the government‘s careful management of

the failed financial company‘s assets as receiver. If this should prove

insufficient, the legislation imposes the burden of paying for orderly

liquidation on a subset of taxpayerslarge financial institutionsrather

than the general public.

4. General Revenue Bailouts

One major concern raised by the extraordinary government bailout

interventions throughout the 2008–2009 economic crisis was the message

effectively sent by the government that it was available as an economic

safety net for private industry. The perception that government assistance

will be forthcoming in the event of economic failure encourages private

businesses to take greater risks than they would in the absence of such a

safety net. Under the circumstances, perhaps it was prudent for Congress

and the President to declare forcefully that there will be ―no more

77. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203,

§ 1105, 124 Stat. 1376, 2121–25, supra note 10, § 210(o); see also supra notes 12–16 and accompanying text.

78. See Block, Bailouts, supra note 22.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 169

government-funded bailouts,‖ in order to limit this type of moral hazard. 79

Realistically, however, future bailouts are inevitable in the event that

economic circumstances become sufficiently dire and the ―tough love‖

approach of simply allowing weak firms to collapse becomes politically

unpalatable.

Special funds may not always be desirable or available for such

bailouts, resulting in interventions that require the expenditure of general

revenue. I use the term ―general revenue bailouts‖ to refer to bailouts for

which costs are broadly spread among the general taxpaying public. Funds

for such general revenue bailouts come from general Treasury Department

accounts. Although minds may differ on accounting and valuation

methodology and on precisely where the information should appear, these

general revenue expenditures are typically visible somewhere in the

federal budget and government financial statements. In other cases, the

source of funds is the Federal Reserve Bank and not the Treasury

Department‘s general revenue fund. Even though these costs do not appear

directly as general revenue expenditures, they indirectly reflect revenue

costs because they reduce funds that would otherwise be paid to the

general Treasury through Federal Reserve remittances. 80

5. Combination Bailouts

Bailouts also can be funded through a combination of special funds and

general revenues. For example, FIRREA established a rather complex

mechanism to provide funding for the 1980s savings and loan bailout.

Funds for the bailout theoretically were to come from the sale of assets

taken from banks in receivership, the sale of nonvoting capital stock to

Federal Home Loan Banks, assessments against certain savings and loan

banks, and the issuance of obligations. 81

In each case, however, it was

recognized that the ―special fund‖ might not be sufficient to cover all

bailout costs; Congress authorized supplemental general revenue funding

from the Treasury Department. 82

Similarly, although the FDIC generates

79. For further discussion of moral hazard issues, see infra notes 333–36 and accompanying text.

80. For a discussion of the Federal Reserve and its surplus remittances to the Treasury, see infra notes 130–33, 147–51 and accompanying text.

81. For a comprehensive treatment of the savings and loan bailout structure and funding

mechanisms provided by FIRREA, see JAMES R. BARTH, THE GREAT SAVINGS AND LOAN DEBACLE 79–99 (1991); Marirose K. Lescher & Merwin A. Mace III, Financing The Bailout Of The Thrift

Crisis: Workings Of The Financing Corporation And The Resolution Funding Corporation, 46 BUS.

LAW. 507 (1991); Michael P. Malloy, Nothing to Fear but FIRREA Itself: Revising and Reshaping the Enforcement Process of Federal Bank Regulation, 50 OHIO ST. L.J. 1117 (1989).

82. Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73,

Washington University Open Scholarship

170 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

funds through the collection of fees from covered banks, these fee-

generated ―special funds‖ may be insufficient, requiring the FDIC to turn

to general revenues.

Various responses to the 2008–2009 economic crisis also adopted a

mixed-resource approach. In November 2008, for example, Citicorp

received an assistance package including Treasury Department funds

through TARP, along with guarantees from the FDIC and the Federal

Reserve. 83

In another program, the Treasury Department protected the

Federal Reserve by agreeing to cover the first $20 billion in Federal

Reserve loans through the latter‘s Term Asset-Backed Securities Loan

Facility (TALF). 84

III. BAILOUT COSTS: WHERE IN THE BUDGET?

A. Introduction

One long-standing debate in budget circles has been the scope of the

federal budget; in other words, the extent to which government

expenditures should be ―on-budget‖ or ―off-budget.‖ In 1967, an

influential report of the President‘s Commission on Budget Concepts

argued that the budget should be ―unified,‖ meaning that ―the budget

should, as a general rule, be comprehensive of the full range of Federal

activities. Borderline agencies and transactions should be included in the

budget unless there are exceptionally persuasive reasons for exclusion.‖ 85

The basic logic of the unified budget is that it ―facilitates use of the budget

as an instrument of economic policy, and it enables the government to

§ 211 103 Stat. 183, 218–22 (codified at 12 U.S.C. § 1821(a)(6)(F), (J)(ii) (2006)). Congress provided

backup Treasury funding to permit payment of interest on obligations for the RTC and FSLIC

Resolution Fund. See, e.g., id. § 511 (codified at 12 U.S.C. § 1441(b), (f)(2)(E) (2006)).

83. BD. OF GOVERNORS OF THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE CONGRESS 51 (2009); see also Press Release, U.S. Dep‘t of the Treasury, Joint Statement by Treasury,

Federal Reserve and the FDIC on Citigroup (Nov. 23, 2008), available at http://www.ustreas.gov/

press/releases/hp1287.htm (describing package of guarantees, liquidity access, and capital in exchange for which Citigroup issued preferred stock to the Treasury, FDIC, and the Federal Reserve).

84. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 27–28 (2010). For detailed discussion of Federal Reserve bailout actions, see infra notes 105–29 and accompanying text. For

another example of a joint effort bailout, see the Public-Private Investment Fund (PPIF)/Legacy Loan

Program described in DARRYL E. GETTER & OSCAR R. GONZALES, CONG. RESEARCH SERV., R40413, THE FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC): EFFORTS TO SUPPORT FINANCIAL AND

HOUSING MARKETS 5 (2009).

85. PRESIDENT‘S COMM‘N ON BUDGET CONCEPTS, REPORT OF THE PRESIDENT‘S COMMISSION ON BUDGET CONCEPTS 25 (1967).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 171

establish priorities among programs financed by different sources.‖ 86

Put

more colloquially, in order to make better allocative policy choices,

everything should be on the table for discussion.

Budget figures today are presented in a variety of different, and

sometimes schizophrenic, accounts. 87

In addition to ―unified‖ or

―consolidated‖ accounts, budget figures include ―on-budget‖ and ―off-

budget‖ totals. 88

Complicating matters further, many government or

government-supported activities are conducted through separate entities,

which include wholly and partially government-owned corporations, as

well as privately owned, government-sponsored enterprises (GSEs). 89

Although technically private, GSEs are federally chartered corporations

entitled to certain privileges and subject to limitations not otherwise

applicable to private corporations. 90

Perhaps the most well-known GSEs

are housing and mortgage loan giants Fannie Mae and Freddie Mac.

Activities of wholly owned government corporations are technically

part of the federal budget. 91

Because they use different accounting and

financial standards, however, their financial information is presented

separately and cannot be readily incorporated into regular budget

schedules. On the other hand, GSEs and partially government-owned

corporations do not appear at all in any of the various budget accounts,

unified or not. Depending upon the extent of government involvement,

however, some of these partially owned government entities and GSEs are

engaged in activities that arguably should be part of the overall federal

86. ALLEN SCHICK, THE FEDERAL BUDGET: POLITICS, POLICY, AND PROCESS 42–43 (3d ed.

2007). 87. For a discussion of the off-budget device and the variety of budget accounts, see Cheryl D.

Block, Congress and Accounting Scandals: Is the Pot Calling the Kettle Black?, 82 NEB. L. REV. 365, 429 (2003) [hereinafter Block, Accounting Scandals]; see also Cheryl D. Block, Budget Gimmicks, in

FISCAL CHALLENGES: AN INTERDISCIPLINARY APPROACH TO BUDGET POLICY 39, 46–47 (Elizabeth

Garrett et al. eds., 2008). 88. At least technically, the term ―off-budget‖ refers only to the two social security programs and

the postal service trust fund that are statutorily excluded from the budget. Budget Enforcement Act of

1990, Pub. L. No. 101-508, § 13301, 104 Stat. 1388, 1388–623 (codified at 2 U.S.C. § 632(a) (2006)) (making social security program ―off-budget‖); Omnibus Budget Reconciliation Act, Pub. L. No. 101-

239, § 4001(a), 103 Stat. 2106, 2133 (1989) (codified at 39 U.S.C. § 2009a (2006)) (making the postal

service trust fund ―off-budget‖). 89. For a discussion of the differences among these various entities, see Block, Accounting

Scandals, supra note 87, at 432–42.

90. See id. at 435–39; see also GSEs: Recent Trends and Policy: Hearing Before the Subcomm. on Capital Mkts., Sec. and Gov’t Sponsored Enters. of the H. Comm. on Banking and Fin. Servs.,

105th Cong. 1 (1997) (statement of James L. Bothwell, Chief Economist). For further discussion of the

housing GSEs, see infra notes 179–87 and accompanying text. 91. Examples include the Pension Benefit Guarantee Corporation, the Commodity Credit

Corporation, and the Federal Crop Insurance Corporation.

Washington University Open Scholarship

172 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

budget. To the extent that such entities are not so reflected, I refer to them

as ―off-off budget.‖ In fact, the move to privatize many government

functions might skeptically be viewed as a budget gimmick to move

activities off-off budget and reduce the apparent size of the deficit. This

phenomenon is not limited to the United States. Governments faced with

increasing risks and fiscal uncertainties have turned to privatizing many

state functions, accompanying this privatization with implicit or explicit

state guarantees. According to one economist, ―[t]hese off-budget

programs and obligations involve hidden fiscal costs, with implicit and

contingent liabilities that may result in excessive requirements for public

financing in the medium and long term.‖ 92

A true reflection of the budget

deficit would require some mechanism to incorporate these entities, along

with the implicit and contingent liabilities they impose. 93

Various ―off-off-budget‖ entities have played a significant role in

recent government bailout activities. The government‘s substantial

investments in the housing-related GSEs‘ financial instruments, and the

conservatorship of Fannie Mae and Freddie Mac, raise questions about the

extent to which these otherwise nongovernment entities should be

incorporated into the budget. 94

In addition, the Federal Reserve, in

particular, played an extraordinary and unprecedented role in recent

government bailout interventions. The sections that follow begin by

briefly discussing the Federal Reserve‘s general authority and operations,

followed by an examination of the Federal Reserve Bank‘s recent actions

and their budget implications. This Part closes with a brief exploration of

the bailout-related interventions involving housing-related GSEs.

B. The Federal Reserve

1. The Federal Reserve and Monetary Policy

One ―off-off-budget‖ entity that stands in a class by itself is the Federal

Reserve Bank, a uniquely independent government agency responsible for

managing monetary policy. The Federal Reserve Bank was initially

established as the nation‘s central bank by the Federal Reserve Act of

1913. 95

Although subject to congressional oversight, the Bank is an

92. Hana Polackova Brixi, Government Contingent Liabilities: A Hidden Risk to Fiscal Stability, 13 J. OF PUB. BUDGETING, ACCT. & FIN. MGMT. 582, 582 (2001).

93. For further discussion of budgeting for implicit guarantees, see infra notes 334–36 and

accompanying text. 94. See infra notes 183–94.

95. Federal Reserve Act of 1913, Pub. L. No. 63-43, 38 Stat. 251 (codified as amended at 12

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 173

independent agency and does not receive appropriations from Congress.

Three component parts make up the Federal Reserve System: (1) a central

Board of Governors in Washington, D.C.; (2) twelve regional Federal

Reserve Banks; and (3) member banks. 96

The Federal Reserve is charged

with four major responsibilities: (1) formulating and implementing

monetary policy; (2) supervising and regulating banks; (3) serving as the

―lender of last resort‖ for banks and otherwise containing systemic risks in

the financial system; and (4) serving as a ―fiscal agent for the [federal]

government and clearinghouse for private sector financial transactions.‖ 97

Formation and implementation of monetary policy are probably the

most important, and certainly the most closely watched, of the Federal

Reserve‘s regular activities. The primary functions of monetary policy are

to control the supply and cost of money and credit and to promote stable

prices and maximum sustainable economic growth. 98

Three traditional

monetary policy tools are available to the Federal Reserve. First, the Bank

uses daily open-market transactions to indirectly manage the supply and

demand for money and credit. These daily morning transactions involve

the purchase and sale of U.S. Treasury securities between the New York

Federal Reserve Bank and eligible ―primary dealers.‖ The quantities and

terms of these transactions are driven by the ―federal funds rate target,‖ 99

set by the Federal Open Market Committee (FOMC), the policymaking

arm of the Federal Reserve. The idea effectively is for the Bank to use its

―monopoly power‖ to move the market interest rate for intrabank loans to

its desired target. Additional regular monetary policy tools available to the

Federal Reserve include its authority to establish discount rates at which it

will extend short-term credit to eligible banks, and its power to alter the

cash reserve amounts required to be maintained at the Bank by depository

institutions. 100

U.S.C. § 343 (2006)). Throughout this Article, the Federal Reserve Bank will alternatively be referred

to as ―the Bank‖ or ―the Federal Reserve.‖ 96. BD. OF GOVERNORS OF THE FED. RESERVE SYS., THE FEDERAL RESERVE SYSTEM: PURPOSES

AND FUNCTIONS 3 (9th ed. 2005) [hereinafter PURPOSES AND FUNCTIONS]. Member banks include all

nationally chartered banks and eligible nonnational banks that elect to join. Id. at 12. 97. Id. at 1; see also PAULINE SMALE, CONG. RESEARCH SERV., RS20826, STRUCTURE AND

FUNCTIONS OF THE FEDERAL RESERVE SYSTEM 1 (2005).

98. MARC LABONTE, CONG. RESEARCH SERV., RL30354, MONETARY POLICY AND THE FEDERAL RESERVE: CURRENT POLICY AND CONDITIONS 1 (2009).

99. The federal funds rate is the rate at which commercial banks will lend to one another. Id. 100. Id. at 2. For a useful and accessible account of the Federal Reserve‘s traditional roles and its

expanded actions in response to financial crisis, see Stephen G. Cecchetti, Crisis and Responses: The

Federal Reserve in the Early Stages of the Financial Crisis, 23 J. ECON. PERSP. 51 (2009).

Washington University Open Scholarship

174 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

2. The Federal Reserve Bank’s Role in Recent Bailout Activity

One unusual feature of the 2008–2009 federal government rescue effort

is the extent to which bailout funding was provided through the Federal

Reserve Bank, rather than the Treasury Department. As the Federal

Reserve‘s response to economic crisis has expanded to include new and

innovative approaches, many of its actions more closely resemble fiscal

policy than monetary policy. 101

This transition from monetary to fiscal

policy occurs when the Bank moves from actions simply intended to

provide liquidity to actions intended to provide capital assistance to

struggling firms. The Bank‘s targeted assistance to individual firms or

industries fits within my working definition of bailout as ―a form of

government assistance or intervention specifically designed or intended to

assist enterprises facing financial distress and to prevent enterprise

failure.‖ 102

Indeed, several of the Federal Reserve‘s direct loan and loan

guarantee arrangements with individual private entities appear very similar

in structure to some of the direct loans and loan guarantees from the

Treasury Department through TARP. Some are even joint efforts

involving the Federal Reserve and TARP funds. 103

To the extent that the

Federal Reserve makes loans or troubled asset acquisition arrangements

similar to those otherwise available through the Treasury Department,

taxpayers may be exposed to risk beyond statutory limits authorized by

Congress under the EESA and other legislative rescue programs. This, of

course, raises questions about the extent to which the Federal Reserve

should be authorized to institute such programs in the first place without

specific congressional authority. As fascinating as these questions are,

they are generally beyond the scope of this Article, which focuses

primarily on federal budget implications of various bailout-like

interventions. 104

101. Fiscal policy generally ―is concerned with the determination of tax rates and the level of government spending and is the joint responsibility of Congress and the President.‖ GEOFFREY

WOGLOM, MODERN MACROECONOMICS 5 (1988). In contrast, monetary policy ―is concerned with

settling the level of money supply and is the responsibility of the Federal Reserve System.‖ Id.; see also MARC LABONTE, CONG. RESEARCH SERV., RL30354, MONETARY POLICY AND THE FEDERAL

RESERVE: CURRENT POLICY AND CONDITIONS 1–2 (2009) (―Broadly speaking, monetary policy is any

policy related to the supply of money. . . . The dominant influence on the U.S. money supply . . . comes from the policies of the nation‘s central bank, the Federal Reserve . . . .‖).

102. See supra text accompanying note 22 (definition of bailout).

103. See discussion infra notes 126–29 and accompanying text. 104. The 2010 financial reforms made several changes to the Federal Reserve‘s authority. Dodd-

Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, tit. XI, 124 Stat. 1376, 1596–1641 (Federal Reserve System Provisions). Some of these are considered at notes

111, 167, 341–46 and accompanying text.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 175

3. Expansion of Federal Reserve Activity in Response to Crisis

Monetary policy, of course, is the Federal Reserve‘s ongoing, regular

focus. Times of economic stress, however, call upon the Bank‘s

responsibility to ―contain financial disruptions and [prevent] their spread

outside the financial sector.‖ 105

Even in difficult economic times, the Bank

typically turns first to its traditional monetary policy toolbox. For

example, the Federal Reserve can increase liquidity and make credit more

freely available through reductions in the federal funds rate target or

discount rate. These traditional tools were used early on and increasingly

throughout the economic downturn that began in the summer of 2007.

Federal Reserve Chairman Bernanke reported that the Bank ―responded

forcefully‖ by dramatically reducing the federal funds rate target, noting

that by ―historical comparison, this policy response stands out as

exceptionally rapid and proactive.‖ 106

Beginning in 2008 and continuing

through much of 2010, the FOMC ―maintained a target range of 0 to 1/4

percent for the federal funds rate.‖ 107

Economic crises severely test the limits of traditional monetary policy.

Traditional tools have little or no continued impact when the Federal

Reserve has already reduced interest rates to virtually zero, when the threat

of systemic economic failure extends beyond financial industries into the

broader economy and when the cure for a substantial number of distressed

firms demands more than just short-term liquidity assistance. By all

accounts, economic events in 2008 and 2009 were extraordinary.

Chairman Bernanke himself observed that ―[e]xtraordinary times call for

extraordinary measures. Responding to the very difficult economic and

financial challenges we face, the Federal Reserve has gone beyond

traditional monetary policy making to develop new policy tools to address

the dysfunctions in the nation‘s credit markets.‖ 108

From mid-2007 through 2009, this response included an unprecedented

and dizzying array of new programs or ―facilities,‖ creating a veritable

105. PURPOSES AND FUNCTIONS, supra note 96, at 16.

106. Ben S. Bernanke, Chairman, Fed. Reserve, Federal Reserve Policies to Ease Credit and Their

Implications for the Fed‘s Balance Sheet, Speech at the National Press Club Luncheon (Feb. 18, 2009) [hereinafter Bernanke, Press Club Speech], available at http://www.federalreserve.gov/newsevents/

speech/bernanke20090218a.htm.

107. BD. OF GOVERNORS OF THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE CONGRESS (2009); Press Release, Bd. of Governors of the Fed. Reserve Sys. (Dec. 16, 2008),

available at http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm (FOMC statement

announcing decisions to reduce the federal funds target rate to 0 to 1/4 percent). 108. Bernanke, Press Club Speech, supra note 106.

Washington University Open Scholarship

176 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

―alphabet soup‖ of new acronyms. 109

With such extraordinary new

activities, Chairman Bernanke was moving the Bank into uncharted

waters. 110

As authority for much of this extraordinary action, the Bank

turned to a provision in the Federal Reserve Act granting expanded

emergency lending authority in ―unusual and exigent circumstances.‖ 111

Until the latter part of 2008, this extraordinary emergency power had not

been used by the Federal Reserve to extend credit since the Great

Depression. 112

Some Federal Reserve actions taken pursuant to its

emergency authority provided targeted assistance to specific firms or

facilitated specific acquisition transactions, 113

while others created lending

109. Some of the new programs introduced or announced in 2007 and 2008 include a Term Auction Facility (TAF) (Dec. 2007); Liquidity Swap Lines (Dec. 2007); Terms Securities Lending

Facility (TSLF) (Mar. 2008); Primary Dealer Credit Facility (PDCF) (Mar. 2008); Asset-Backed

Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) (Sept. 2008); Commercial Paper Funding Facility (CPFF) (Oct. 2008); Money Market Investor Funding Facility (MMIFF) (Oct.

2008); Term Asset-Backed Securities Loan Facility (TALF) (Nov. 2008). See BD. OF GOVERNORS OF

THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE CONGRESS 47–50 (2009). In light of

financial improvements, many of the new programs have expired or been closed. BD. OF GOVERNORS

OF THE FED. RESERVE SYS., CREDIT AND LIQUIDITY PROGRAMS AND THE BALANCE SHEET: THE FEDERAL RESERVE‘S RESPONSE TO THE CRISIS (2010), available at http://www.federalreserve.gov/

monetarypolicy/bst_crisisresponse.htm (describing expiration or closing of MMIFF, AMLF, CPFF,

and TSLF programs). 110. See, e.g., AXILROD, supra note 61, at 155 (―In the end, the innovative measures eventually

put in place by the Fed were path breaking.‖); ETHAN S. HARRIS, BEN BERNANKE‘S FED: THE

FEDERAL RESERVE AFTER GREENSPAN 178 (2008) (referring to Bank actions in 2008 as including ―the fastest policy change in the modern history of the Fed‖ and ―an unprecedented array of new programs

to directly add liquidity to credit markets‖).

111. Federal Reserve Act of 1913, Pub. L. No. 63-43, § 13(3), 38 Stat. 251, 264 (codified at 12 U.S.C. § 343 (2006)) (emergency power added to the Federal Reserve Act in 1932) (―In unusual and

exigent circumstances, the Board of Governors of the Federal Reserve System . . . may authorize any

Federal reserve bank . . . to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange . . . [p]rovided, [t]hat . . . the Federal reserve bank [obtains] evidence that such

individual, partnership, or corporation is unable to secure adequate credit accommodations from other

banking institutions.‖ (emphasis added)) (prior to amendment by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010). The 2010 Act replaced the statutory references in this

emergency power provision to ―individual, partnership, or corporation‖ with references to ―participant

in any program or facility with broad-based eligibility.‖ Id. § 1101(a)(2)–(5). This change is an attempt to hold the Federal Reserve more closely to its monetary policy functions. The Federal Reserve can no

longer use its emergency power ―for the purpose of assisting a single and specific company avoid

bankruptcy.‖ Id. § 1101(a)(6). 112. An Examination of the Extraordinary Efforts by the Federal Reserve Bank to Provide

Liquidity in the Current Financial Crisis: Hearing Before the H. Comm. on Financial Servs., 111th

Cong. 8 (2009) (statement of Ben S. Bernanke, Chairman, Bd. of Governors of the Fed. Reserve Sys.). 113. For a description of some of these specifically targeted assistance efforts, see BD. OF

GOVERNORS OF THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE CONGRESS 50–51

(2009) (description of Federal Reserve actions to assist Bear Stearns, AIG, Citicorp, and Bank of America). Such Federal Reserve assistance to individual firms is no longer permitted. See supra note

111.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 177

facilities and programs that were made more broadly available. 114

Most of the Federal Reserve‘s unprecedented new programs or

facilities in 2008 and 2009 shared several features. 115

Notable patterns

reflected in the recent Federal Reserve responses include (1) an expansion

of the class of institutions to which assistance is offered; 116

(2) a move

from extremely short-term (i.e., overnight) loans to longer-term loans; 117

(3) a willingness to provide specifically targeted assistance to individual

firms or specific industries threatened with economic failure; 118

(4) a

dramatic expansion of the types of collateral that the Bank is willing to

accept; 119

and (5) a willingness to act jointly with the Treasury Department

and the FDIC. 120

In some cases, the expansion of acceptable collateral led the Bank to

use new and complex funding devices. Rather than hold collateral directly,

the Bank in some cases established separate entities—referred to as

Special Purpose Vehicles (SPVs)—to hold the assets. This creative device

114. See supra note 109. 115. In addition to the Federal Reserve‘s BD. OF GOVERNORS OF THE FED. RESERVE SYS.,

MONETARY POLICY REPORT TO THE CONGRESS (2009), useful sources for more detailed information

on the 2007–2008 new programs include OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at

27–28 (2010); MKTS. GROUP, FED. RESERVE BANK OF N.Y., DOMESTIC OPEN MARKET OPERATIONS

DURING 2008, at 19–25 (2009). 116. Although the Federal Reserve typically extends loans only to banks, the TSLF and PDCF,

both established in March 2008, made loans available to primary dealers. For a brief description of

these programs, see BD. OF GOVERNORS OF THE FED. RESERVE SYS., 95TH ANNUAL REPORT 52–53 (2008) [hereinafter FEDERAL RESERVE 2008 ANNUAL REPORT]. The TALF later made loans even

more broadly available to holders of certain securities backed by student, auto, and other loans. For a

brief description, see id. at 55. See also OFFICE OF THE SPECIAL INSPECTOR GEN. FOR THE TROUBLED ASSET RELIEF PROGRAM, INITIAL REPORT TO CONGRESS 81–83 (2009).

117. Although the Federal Reserve typically extends only overnight loans, special facilities created during the recent economic crisis provided longer terms. For example, TSLF loans were

available for a 28-day term. FEDERAL RESERVE 2008 ANNUAL REPORT, supra note 116, at 52. A more

dramatic expansion was the TALF program, which made loans available for three, and in some cases up to five, years. See Term Asset-Backed Securities Loan Facility: Frequently Asked Questions, FED.

RESERVE BANK OF N.Y. (Apr. 1, 2010), http://www.newyorkfed.org/markets/talf_faq.html.

118. For example, the Federal Reserve, in 2008, provided assistance to Bear Stearns, American International Group, Citigroup, and the Bank of America. FEDERAL RESERVE 2008 ANNUAL REPORT,

supra note 116, at 56–57. Subsequently enacted provisions now prohibit the Federal Reserve from

providing such assistance to individual companies. See supra note 111. 119. For a discussion of Federal Reserve‘s broadening of acceptable collateral through its 2008

new facilities, see NEW YORK FEDERAL RESERVE OPEN MARKET OPERATIONS, supra note 115, at 19–

25. 120. For example, TALF was a joint project with the Treasury Department in which the former

agreed to absorb the first $20 billion in losses on TALF loans. OFFICE OF MGMT. & BUDGET, EXEC.

OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 27–28 (2010). Another collaborative government intervention effort was the joint

Treasury Department, FDIC, and Federal Reserve assistance to Citigroup. Id. at 28.

Washington University Open Scholarship

178 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

was first used in connection with Bank efforts to facilitate J.P. Morgan‘s

acquisition of the ailing Bear Stearns. 121

As the potential bankruptcy of

Bear Stearns—then the nation‘s fifth-largest banking firm—loomed in

March 2008, the Federal Reserve determined that ―a disorderly failure of

Bear Stearns would [threaten] overall financial stability and would most

likely have significant adverse implications for the U.S. economy.‖ 122

J.P.

Morgan was interested in an acquisition, but reluctant to assume Bear

Stearns‘s risky investment portfolio, made up substantially of mortgage-

backed securities and other housing-related investments. To assist with the

$30 billion acquisition of Bear Stearns, the Federal Reserve created

Maiden Lane, a new Delaware-based Limited Liability Company (LLC) to

be wholly owned by the Bank. Immediately after it was formed, the LLC

received a $29 billion nonrecourse loan from the Federal Reserve and a $1

billion subordinate loan from J.P. Morgan, which it then used to purchase

$30 billion in assets from Bear Stearns. These assets were the sole

collateral backing for the loans, which the LLC was expected to repay

through subsequent liquidation of the assets. As a result of this transaction

structure, the first $1 billion in risk of loss was borne by J.P. Morgan and

the remaining risk borne by the Federal Reserve. Although the Federal

Reserve does not hold a direct interest in the high-risk assets associated

with Bear Stearns, it owns them indirectly through its 100% ownership

interest in Maiden Lane.

The Federal Reserve‘s decision to intervene in the Bear Stearns case

was unprecedented in a number of ways. First, the Bank had not

previously ―committed to ‗bailing out‘ a financial entity that was not a

commercial bank.‖ 123

Second, to my knowledge, it had not previously

agreed to take an interest in troubled assets as collateral for a loan. Third,

the Bank had not previously used an intermediary entity through which to

funnel loans. The Bank has since used this intermediary vehicle approach

more broadly for other new lending programs. In October 2008, for

example, the Bank created a similar LLC to implement its new

Commercial Paper Funding Facility (CPFF), which was created to

improve liquidity and availability of credit for households and

121. For a description of events leading up to the Bear Stearns assistance and the transactions

themselves, see GARY SHORTER, CONG. RESEARCH SERV., RL34420, BEAR STEARNS: CRISIS AND ―RESCUE‖ FOR A MAJOR PROVIDER OF MORTGAGE-RELATED PRODUCTS (2008).

122. BD. OF GOVERNORS OF THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE

CONGRESS 50 (2009). 123. GARY SHORTER, CONG. RESEARCH SERV., RL34420, BEAR STEARNS: CRISIS AND ―RESCUE‖

FOR A MAJOR PROVIDER OF MORTGAGE-RELATED PRODUCTS 1 (2008).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 179

businesses. 124

The Bank lent money to the LLC, which, in turn, used the

funds to acquire three-month (short-term) commercial paper from eligible

issuers. Later in the same month, the Bank created additional LLCs for

purposes of implementing a new Money Market Investor Funding Facility

(MMIFF), which used funds loaned by the Bank to acquire various

eligible money market instruments. 125

One of the most dramatic new Federal Reserve programs was the

TALF, created by the Bank in November 2008, also pursuant to its

emergency authority. 126

Under expanded eligibility rules, this facility was

made available to ―any U.S. company that owns eligible collateral[,] . . .

provided the company maintains an account relationship with a TALF

Agent.‖ 127

Categories of acceptable collateral were also expanded to

include securities backed by eligible auto loans, student loans, credit card

loans, or small business loans guaranteed by the Small Business

Administration. As originally announced, the program was to make

available up to $200 billion in one-year nonrecourse loans. Subsequent

announcements extended the loan term to three years, expanded the types

of eligible collateral, and indicated that the Federal Reserve was prepared

to expand the size of the program to as much as $1 trillion. 128

Another

unusual feature of the program was the participation of the U.S. Treasury,

which provided $20 billion in credit protection to the New York Federal

Reserve Bank using funds authorized under TARP. 129

Through these

various new programs, the Federal Reserve clearly moved far beyond its

traditional role of issuing overnight loans to banks.

124. Press Release, Bd. of Governors of the Fed. Reserve Sys. (Oct. 7, 2008), available at http://

www.federalreserve.gov/newsevents/press/monetary/20081007c.htm (announcing creation of CPFF

facility). 125. Press Release, Bd. of Governors of the Fed. Reserve Sys. (Oct. 21, 2008), available at http://

www.federalreserve.gov/newsevents/press/monetary/20081021a.htm (announcing creation of MMIFF

facility). 126. Press Release, Bd. of Governors of the Fed. Reserve Sys. (Nov. 25, 2008), available at http://

www.federalreserve.gov/newsevents/press/monetary/20081125a.htm.

127. Term Asset-Backed Securities Loan Facility: Terms and Conditions, FED. RESERVE BANK OF N.Y. (Nov. 13, 2009), http://www.newyorkfed.org/markets/talf_terms.html.

128. Press Release, Bd. of Governors of the Fed. Reserve Sys. (Feb. 10, 2009), available at http://

www.federalreserve.gov/newsevents/press/monetary/20090210b.htm. 129. Id.; see also BD. OF GOVERNORS OF THE FED. RESERVE SYS., CREDIT AND LIQUIDITY

PROGRAMS AND THE BALANCE SHEET: OTHER LENDING FACILITIES (Feb. 5, 2010), available at http://

www.federal reserve.gov/monetarypolicy/bst_lendingother.htm.

Washington University Open Scholarship

180 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

4. Budget Implications of Federal Reserve Programs

a. The Federal Reserve and Its Balance Sheets

To understand the budget implications of the Federal Reserve‘s

extraordinary bailout-like interventions, it will be helpful first to consider

how the Bank maintains its balance sheets. The Federal Reserve‘s balance

sheet is usually straightforward and not subject to dramatic changes; until

recently, changes from month to month or even year to year have not been

especially remarkable. Total assets on the Federal Reserve balance sheet

between December 2000 and December 2007, for example, increased at a

rather steady rate of nine to ten percent each year, ending 2007 at

approximately $900 billion. 130

U.S. Treasury securities typically made up

the bulk of the Federal Reserve‘s assets. From the beginning of 2000 until

the end of 2007, for instance, the proportion of Federal Reserve assets held

outright as U.S. Treasury securities remained relatively constant at

approximately eighty to eighty-five percent. 131

Most of the Bank‘s income

derives from interest on securities acquired through the open market,

―interest on foreign currency investments,‖ ―loans to depository

institutions‖ and other borrowers, and fees charged for its services to

depository institutions or for other services. 132

Historically, the Federal

Reserve has not only been financially self-sustaining, but has generated

surplus, which is remitted to the Treasury and reflected in the federal

budget as revenue. Annual surplus income transferred from the Federal

Reserve to the Treasury has typically ranged from $20 to $30 billion. 133

As some colloquially put it, the Federal Reserve has the unlimited and

extraordinary power to ―make‖ or ―print‖ money. The Bank effectively

can increase the money supply simply by expanding its lending activity.

For example, if the Bank extends an additional loan to one of its

depository institutions, the increased loan amount is reflected on the

liability side of the Federal Reserve‘s balance sheet as an increase in the

130. CONG. BUDGET OFFICE, THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE‘S ACTIONS DURING THE FINANCIAL CRISIS 4 fig.1 (2010).

131. Data was derived by comparing the last weekly Federal Reserve release for each year from

2000 through 2007. H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE, http://www.federalreserve.gov/releases/h41 (last visited Aug. 22, 2010).

132. PURPOSES AND FUNCTIONS, supra note 96, at 11.

133. The Budget and Economic Outlook: Fiscal Years 2009 to 2010: Hearing Before the S. Comm. on the Budget, 111th Cong. 35 (2009) (statement of Robert A. Sunshine, Acting Director,

Cong. Budget Office); see also CONG. BUDGET OFFICE, THE BUDGETARY IMPACT AND SUBSIDY

COSTS OF THE FEDERAL RESERVE‘S ACTIONS DURING THE FINANCIAL CRISIS 11 (2010) (reporting annual remittances between $19 and $34 billion for fiscal years 2000–2008).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 181

borrowing institution‘s ―bank account,‖ i.e., liquid funds now available for

immediate disbursement to the borrowing institution. The same amount is

included as a loan on the asset side of the balance sheet, i.e., as an amount

that the Federal Reserve is entitled to be repaid.

When the Federal Reserve expands its lending activity, it increases the

cash or money supply. Without any offsetting moves, such Federal

Reserve action would create the risk of inflation. Given such concerns, the

Bank does not often expand its lending activities without taking some type

of ―sterilizing‖ action such as simultaneous sales of U.S. Treasury

securities. Through such sales, the Bank simultaneously decreases the

amount of Treasury securities and increases the amount of loans on the

asset side of the balance sheet. Assuming the amounts are the same, the

two transactions ―neutralize‖ each other, leaving the aggregate assets and

liabilitiesor bottom lineof the Bank‘s balance sheet unchanged.

Such simultaneous ―neutralizing‖ transactions may not change the

overall size of the Federal Reserve‘s balance sheet, but they do change the

composition of its asset portfolio. After the transactions, the balance sheet

will reveal a greater proportion of assets in the form of loans and a lesser

proportion in U.S. Treasury securities. To the extent that the Bank has a

smaller proportion of generally secure Treasury securities and a larger

proportion of loans, its overall portfolio is riskier. A comparison of

Federal Reserve balance sheet information from 2007 and 2008, for

example, reveals a dramatic shift in the makeup of Federal Reserve assets.

At year end 2007, Treasury securities held outright constituted

approximately eighty-two percent of total assets, while loans constituted

approximately seven percent of total assets. 134

These relative proportions

were consistent with prior years. 135

By year end 2008, however, Treasury

securities held outright had declined to only twenty-two percent of total

assets. 136

In addition, the categories of assets listed had expanded

dramatically to include entries for a variety of new lending programs. 137

More than fifty percent of total assets at year end 2008 represented some

134. Data was derived from H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE

STATISTICAL RELEASE (Dec. 27, 2007), http://www.federalreserve.gov/releases/h41/20071227. For purposes of these computations, I consolidated repurchase agreements, term auction credit, and other

loans together as ―loans.‖

135. Data was derived by comparing year-end H.4.1. Federal Reserve Statistical Releases, available at H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE,

http://www.federalreserve.gov/releases/h41.

136. H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE (Dec. 29, 2008), http://www.federalreserve.gov/releases/h41/200812278.

137. Id.

Washington University Open Scholarship

182 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

type of loan. 138

Nonetheless, economic improvements and repayments

through the end of 2009 improved the composition of the Federal

Reserve‘s balance sheet; the proportion of assets in less risky Treasury

securities held outright by that time had returned to approximately eighty-

one percent. 139

Early on in the crisis, new Federal Reserve programs were structured to

―neutralize‖ any increases in Federal Reserve lending with offsetting

reductions in U.S. Treasury security holdings. In other words, the Federal

Reserve maintained the overall size of the balance sheet or ―money

supply.‖ For example, despite the introduction of several new programs in

the latter half of 2007, total assets on the Federal Reserve‘s balance sheet

at the end of 2007 were approximately $930 billion, only a 9.8% increase

from the previous year. 140

Beginning in the fall of 2008, however, Federal

Reserve actions began to dramatically expand the overall balance sheet.

By the end of 2008, total assets had increased to approximately $2.3

trillion. 141

To allow further expansion of the balance sheet without

―printing money,‖ the Federal Reserve also sought assistance from the

Treasury Department, which agreed to sell additional U.S. Treasury

securities directly to the public through a temporary Supplemental

Financing Program. 142

Funds from the security sales pursuant to this

program were kept in a separate U.S. Treasury supplemental account

maintained at the Bank. 143

Although the composition of the Federal

Reserve‘s balance sheet returned to its precrisis proportionate amount of

138. Id. For purposes of these computations, I also included amounts from new lending facilities

and programs. See also Ben S. Bernanke, Chariman, Fed. Reserve, The Federal Reserve Balance Sheet, Speech at the Federal Reserve Bank of Richmond 2009 Credit Markets Symposium (Apr. 3,

2009) [hereinafter Bernanke, Richmond Speech], available at http://www.federalreserve.gov/news events/speech/bernanke20090403a.htm (indicating that short-term loans to financial institutions then

made up 45% of the total balance sheet, and direct lending to borrowers and investors constituted

12.5%). 139. Data was derived from H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE

STATISTICAL RELEASE (Dec. 31, 2009), http://www.federalreserve.gov/releases/h41/20091231.

140. H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE (Dec. 27, 2007), http://www.federalreserve.gov/releases/h41/20071227.

141. Data was derived by comparing ―total factors supplying reserve funds‖ entry on the Federal

Reserve‘s weekly balance sheet statements from Dec. 29, 2008, and Dec. 27, 2007. H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE, http://www.federalreserve.gov

/releases/h41.

142. Press Release, U.S. Dep‘t of the Treasury, Treasury Announces Supplementary Financing Program (Sept. 17, 2008), available at http://www.ustreas.gov/press/releases/hp1144.htm.

143. Press Release, Fed. Reserve Bank of N.Y., Statement Regarding Supplementary Financing

Program (Sept. 17, 2008), available at http://www.newyorkfed.org/markets/statement_091708.html.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 183

about eighty percent in Treasury securities, the size of the Bank‘s balance

sheet remains at approximately $2.3 trillion. 144

b. The Impact of the Federal Reserve Bank’s Actions on the

Federal Budget

Federal Reserve Chairman Bernanke began a 2009 speech to the

Federal Reserve Bank of Richmond, recognizing,

[i]n ordinary financial and economic times, my topic, ―The Federal

Reserve‘s Balance Sheet,‖ might not be considered a ―grabber.‖ But

these are far from ordinary times. To address the current crisis, the

Federal Reserve has taken a number of aggressive and creative

policy actions, many of which are reflected in the size and

composition of the Fed‘s balance sheet. 145

Since the Bank is an ―off-off budget‖ agency, its expenses are not

reflected at all in the federal budget. Taxpayers and legislators

understandably should be concerned about what Federal Reserve bailout-

type actions are likely to cost the public, in addition to funds already

explicitly authorized by Congress for TARP and other statutory

programs. 146

In the end, the answer is, perhaps, nothing. The Federal Reserve has

not experienced an annual net operating loss since 1915, 147

and despite its

recent forays into new programmatic territory, has taken various

precautions such that an annual net operating loss in the near future

appears unlikely. 148

Indeed, the worst now appears to be over, and the

Federal Reserve has terminated many of its emergency facilities created in

2008. 149

Since the Federal Reserve Bank is self-supporting and actually

remits revenues to the general Treasury, one might be tempted to be

unconcerned about the cost of recent Federal Reserve programs to general

144. H.4.1: Factors Affecting Reserve Balances, FEDERAL RESERVE STATISTICAL RELEASE (Dec. 31, 2009), http://www.federalreserve.gov/releases/h41/20091231.

145. Bernanke, Richmond Speech, supra note 138 (emphasis added).

146. See, e.g., Challenges Facing the Economy: The View of the Federal Reserve: Hearing Before the H. Comm. on the Budget, 111th Cong. 18 (2009) (statement of Rep. Doggett in questioning Federal

Reserve Chairman Ben Bernanke) (―[R]elying upon the Federal Reserve instead of the Treasury for

bailouts can also mask the true cost to the public in terms of our soaring national debt.‖). 147. U.S. GEN. ACCOUNTING OFFICE, GAO-02-939, FEDERAL RESERVE SYSTEM: THE SURPLUS

ACCOUNT 11 (2002).

148. CONG. BUDGET OFFICE, THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE‘S ACTIONS DURING THE FINANCIAL CRISIS 11 (2010).

149. See supra note 109 (referring to Federal Reserve emergency programs that have expired or

been closed).

Washington University Open Scholarship

184 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

taxpayers. After all, taxpayers will not be called upon to foot the bill for

any Federal Reserve loan defaults or loss in value of other Federal Reserve

assets unless aggregate Bank losses exceed earnings. Chairman Bernanke

is careful to stress that most of the Bank‘s new approaches are reasonably

low risk. For example, he notes that the Bank‘s direct loans tend to be

overcollateralized and often made with recourse to the borrower‘s other

assets in the event of nonpayment. 150

Several programs charge fees, in

addition to interest, in order to make the program less attractive and,

hence, ―the last rather than the first resort‖ for borrowing. 151

Despite Chairman Bernanke‘s assurances, there are reasons for

concern. For a period of time in 2008, the Federal Reserve‘s balance sheet

was heavily weighted to higher-risk assets, rather than the more secure

U.S. Treasury issues it usually holds. 152

Its assets also continue to include

net portfolios held through the Bank‘s interest in numerous SPVs,

including three different Maiden Lane LLCs and a CPFF LLC. 153

Chairman Bernanke concedes high risk with respect to some assets, but

argues that the proportion of the Bank‘s assets that are high risk is

extremely low. 154

Even though risks may be reasonably low for the moment, future

borrower defaults and declines in value of Bank assets held as collateral

may result in lower Federal Reserve net earnings and, consequently, lower

remittances to the general Treasury. 155

The amount lost to general

revenues from such reduced remittances would represent real taxpayer

cost. Moreover, if the Bank had incurred substantial losses, taxpayers

would be on the line to cover them through general revenues. Although the

extremes are unlikely, Federal Reserve bailout-type actions do have

150. Ben S. Bernanke, Chairman, Fed. Reserve, The Crisis and the Policy Response, Speech at the

Stamp Lecture London School of Economics (Jan. 13, 2009) [hereinafter Bernanke, London Speech], available at http://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm. In fact,

however, many of the loans extended under more recent Federal Reserve programs are nonrecourse.

See, e.g., OFFICE OF THE SPECIAL INSPECTOR GEN. FOR THE TROUBLED ASSET RELIEF PROGRAM, INITIAL REPORT TO CONGRESS 67 (2009) (discussing nonrecourse TALF loans).

151. Bernanke, Richmond Speech, supra note 138.

152. CONG. BUDGET OFFICE, THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE‘S ACTIONS DURING THE FINANCIAL CRISIS 2–5 (2010).

153. See supra notes 122–25 and accompanying text.

154. Bernanke, London Speech, supra note 120. 155. Perhaps surprisingly, CBO recently estimated that the Federal Reserve‘s expanded activity to

stabilize the financial system in 2007–2009 may actually result in increased remittances to the U.S.

Treasury. CONG. BUDGET OFFICE, THE BUDGETARY IMPACT AND SUBSIDY COSTS OF THE FEDERAL RESERVE‘S ACTIONS DURING THE FINANCIAL CRISIS 4–5, 11 (2010). At the same time, however, the

report stresses that these projections are now more uncertain because ―the system‘s asset holdings are

now riskier, exposing the central bank to a considerably greater possibility of losses than its usual holdings . . . .‖ Id. at 5.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 185

potential costs to the taxpayer that are less visible but, nevertheless, quite

real.

To be fair, the Federal Reserve Bank, under the strong leadership of

Chairman Bernanke, has done its best under difficult conditions to act as a

good-faith and careful steward of monetary policy and to contain systemic

financial risk. Still, the Federal Reserve‘s recent bailout-like actions may

impose costs on the general public even if the Bank continues to generate

surplus that it remits to the general Treasury. The fact remains that the

Federal Reserve has unlimited authority to continue lending and to

continue expanding the money supply. Despite the best of intentions, the

real cost of the Bank‘s rescue efforts in the long run could be increased

inflation. With respect to the Bank‘s balance sheet, the FOMC has noted

that ―it expects the size of the balance sheet to remain at a high level for

some time as a result of open market operations and other measures to

support financial markets and to provide additional stimulus to the

economy.‖ 156

While aware of traditional inflationary concerns that might

be raised by an enlarged balance sheet, the FOMC notes that inflation is

expected to remain low through 2011. 157

Although inflation ultimately was

not a problem in the most recent spate of Federal Reserve activity, it

remains a possibility with respect to future Federal Reserve actions.

5. Federal Reserve Bank Budget Status and Reporting

The Federal Reserve is historically and uniquely an ―off-off budget‖

independent government agency. Other than a one-line entry under

―Miscellaneous Receipts‖ for ―Deposits of Earnings by Federal Reserve

Banks,‖ the federal budget does not include information about Federal

Reserve Bank revenues and expenditures. Annual federal budget

appendices typically note that ―[t]he Board of Governors of the Federal

Reserve System‘s transactions are not included in the Budget because of

its unique status in the conduct of monetary policy.‖ 158

The 1967 President‘s Commission on Budget Concepts, which

otherwise recommended a completely unified budget, acknowledged the

unique nature of the Federal Reserve. Citing the ―vital flexibility and

156. BD. OF GOVERNORS OF THE FED. RESERVE SYS., MONETARY POLICY REPORT TO THE

CONGRESS 2 (2009). 157. Id. at 2–3.

158. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, BUDGET OF THE UNITED STATES GOVERNMENT, FISCAL YEAR 2009 app. at 1273 (2008). For informational purposes, however,

the budget appendix generally does include a broad summary of the Board of Governor‘s

administrative budget. Id. app. at 1274.

Washington University Open Scholarship

186 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

independence‖ of the Federal Reserve‘s monetary policy and the different

nature of the Bank‘s receipts and expenditures, the Commission

recommended that ―[t]he payment of excess Federal Reserve profits to the

Treasury should continue to be treated as a federal budget receipt. But

other receipts and expenditures of the Federal Reserve banks should

continue to be excluded from the budget.‖ 159

Despite continued recognition of the importance of the Federal

Reserve‘s independence as the agency responsible for monetary policy,

concerns have been raised from time to time about the Bank‘s ―off-off

budget‖ status and the need to make information about its activities more

freely available. However, the most recent serious questions raised in

Congress about the Bank‘s budgetary status were in 1985, when

Representative Lee Hamilton introduced legislation that would have

required the President to include in every budget ―estimated receipts and

expenditures of the Board of Governors of the Federal Reserve System

and all Federal Reserve banks in the fiscal year for which the budget is

submitted and the two fiscal years after that year.‖ 160

In other words, the

proposed legislation would have included the Federal Reserve in the

unified budget. At the request of the Congressional Joint Economic

Committee, the Congressional Budget Office (CBO) prepared a report on

the Federal Reserve‘s budget status. 161

Responding to the argument that

the Federal Reserve‘s annual report should be sufficient public

information, the CBO Report noted that the annual report receives much

less public attention than the Budget and does not include information

comparable to budget information provided for other independent agencies

included in the federal budget appendix. In addition, the Federal Reserve‘s

annual report‘s different accounting practices, including use of a calendar

rather than a fiscal year, make it difficult to comparatively assess the

Bank‘s annual report information. 162

The then CBO director Rudolph Penner subsequently testified:

The current budgetary presentation of the Federal Reserve‘s

finances is incomplete compared with that of other independent

government agencies. . . .

. . . .

159. PRESIDENT‘S COMM‘N ON BUDGET CONCEPTS, REPORT OF THE PRESIDENT‘S COMMISSION

ON BUDGET CONCEPTS 29 (1967).

160. H.R. 1659, 99th Cong. (1st Sess. 1985). 161. CONG. BUDGET OFFICE, THE BUDGETARY STATUS OF THE FEDERAL RESERVE (1985).

162. Id. at 40–44.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 187

On its face, the current budgetary treatment of the Federal

Reserve violates a basic principle of budgeting: namely that the

budget document should be comprehensive about government

operations and should facilitate cost comparisons among agencies

and activities. More particularly, the reporting of net earnings

provides little information about financial performance or operating

characteristics of an agency with the power to create money. 163

Even though the CBO Report itself and Dr. Penner‘s testimony offered

several possible answers to policy and accounting questions that would be

raised by bringing the Federal Reserve System ―on-budget,‖ Dr. Penner

did not express a firm opinion with respect to the proposed legislation,

preferring to leave the matter to congressional judgment. 164

The then

Federal Reserve chairman Paul Volcker, on the other hand, took the firm

position that the ―legitimate objectives of disclosure and public

accountability can be best achieved by retaining independent budgetary

reporting for the Federal Reserve (with our net earnings, as at present,

reflected in the regular budget document.)‖ 165

In the end, Congress did

nothing, leaving the then Federal Reserve Bank chairman Volcker with the

independence he was anxious to preserve.

Many improvements have occurred since 1985, of course. Congress

requires the Federal Reserve to release substantial information, including a

publicly available annual report. 166

In fact, the Bank has voluntarily

released more than the required material. The Bank makes its weekly

balance sheet available to the public online and is working to improve

website accessibility and transparency of information. 167

The concern,

then, is not so much that information is unavailable, but rather that

because of the Federal Reserve‘s unique ―off-off budget‖ status, the

potential costs of its bailout-type activities are not reflected anywhere in

the federal budget and not taken into account more generally as

163. The Budgetary Status of the Federal Reserve Systems: Hearing Before the Subcomm. on

Econ. Goals and Intergovernmental Policy of the J. Econ. Comm., 99th Cong. 1–3 (1985) (statement

of Rudolph G. Penner, Director, Cong. Budget Office). 164. Id.

165. Id. at 154 (statement of Paul A. Volcker, Chairman, Fed. Reserve).

166. See, e.g., BD. OF GOVERNORS OF THE FED. RESERVE SYS., ANNUAL REPORT: BUDGET REVIEW (2008).

167. The 2010 Wall Street Reform Act now subjects the Federal Reserve to additional audit and

transparency requirements. See, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, § 1102, 124 Stat. 1376, 2115–17 (special provisions authorizing the

Comptroller General to audit certain Federal Reserve credit facilities); id. § 1103 (additional public

access to information); id. § 1109 (one-time audit by the General Accounting Office of loans and other financial assistance extended by the Federal Reserve from December 1, 2007, through July 2010).

Washington University Open Scholarship

188 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

policymakers attempt to allocate the use of budgetary resources. While

Federal Reserve financial information is available to those who seek it out,

legislators and the general public simply do not consider this information

with the same degree of attention they pay to the federal budget. Different

accounting procedures also make the figures difficult to compare with

other budgetary information.

With its new programs over the past several years, the Federal Reserve

has moved substantially beyond its regular monetary policy role and has

begun to engage in bailout-type government interventions similar to those

undertaken by the Treasury Department or other government agencies.

Budgetary information on bailout costs is incomplete to the extent that it

does not include Federal Reserve bailout-type activities similar to those of

the Treasury Department under the EESA. For example, special budget-

related provisions in the EESA require that OMB report semiannually to

the President and to Congress on the cost of troubled assets and troubled

asset guarantees and include a description of methods used to derive such

cost estimates. 168

These budget provisions further require a CBO

assessment of these OMB reports. 169

Beginning with its second report,

OMB is directed to explain any differences between its own and CBO

estimates. 170

In addition, budget rules, as amended by EESA, require the

President‘s budget to include two different sets of cost estimates for assets

purchased and sold pursuant to EESA ―troubled asset‖ programs—one

using a net present value and the other a cash-basis method of

accounting. 171

Despite the Federal Reserve‘s acquisition of unusual assets

through devices quite similar to those used by the Treasury Department,

these new budgetary rules do not apply to the ―off-off budget‖ Federal

Reserve.

The extraordinary and complex array of new Federal Reserve programs

has begun to blur the traditional boundary between the traditionally

fiercely independent Federal Reserve Bank and the Treasury Department.

Indeed, Chairman Bernanke has conceded, in particular, that ―CPFF and

the TALF are rather unconventional programs for a central bank to

undertake.‖ 172

An unusual joint Federal Reserve-Treasury Department

168. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 202(a), 122 Stat.

3765, 3832–33 (to be codified at 12 U.S.C. §§ 5201–5261). 169. Id. § 202(b).

170. 12 U.S.C. § 5252 (Supp. 2009).

171. 31 U.S.C. 1105(a) (2006 & Supp. 2009). See infra notes 222–44 and accompanying text for further discussion of the debate over net present value versus cash-method accounting for purposes of

estimating bailout costs.

172. Bernanke, Richmond Speech, supra note 138.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 189

press release issued in March 2009 suggests that both agencies are acutely

aware that recent events have tested traditional boundaries. 173

The joint

statement announces several broad principles upon which the two agencies

agree, including the need for an early government response framework to

address potential failure of systemically critical financial institutions and

the need for such framework legislation to ―spell out to the extent possible

the expected role of the Federal Reserve and other U.S. government

agencies.‖ 174

Although bringing the Federal Reserve fully ―on-budget‖ or subjecting

its actions to the congressional appropriations process may be too extreme,

the budget should at least reflect extraordinary Federal Reserve actions

that involve fiscal, as opposed to traditional, monetary policymaking.

Moreover, the Bank and the Treasury Department should use consistent

methodologies to value collateral backing loans and troubled assets held

outright. Even if no general taxpayer dollars were ultimately ―spent‖ as a

result of the Federal Reserve‘s bailout-like interventions, amounts

disbursed by all federal agencies involved in providing bailout-like

assistance should be aggregated and reported in a consistent fashion so

that all bailout-type government intervention risks and costs can be

meaningfully assessed and compared.

C. Other ―Off-Budget‖ Bailout Issues

1. Housing-Related GSEs

One of the most dramatic episodes in the recent bailout crisis was the

government takeover of the ―off-off budget GSEs,‖ Fannie Mae and

Freddie Mac. 175

Both of these independent housing entities were created

by federal charter to ―provide liquidity and stability in the home mortgage

market, thereby increasing the flow of funds available to mortgage

borrowers.‖ 176

Because of the important public good they were expected to

provide for home mortgage markets, Fannie Mae‘s and Freddie Mac‘s

congressional charters gave them various advantages, including exemption

from certain income taxes, exemption from Securities and Exchange

173. Press Release, Bd. of Governors of the Fed. Reserve Sys., The Role of the Federal Reserve in

Preserving Financial and Monetary Stability (Mar. 23, 2009), available at http://www.federalreserve. gov/newsevents/press/monetary/20090323b.htm.

174. Id.

175. See supra notes 24–25, 89–94 and accompanying text; infra notes 175–82 and accompanying text.

176. CONG. BUDGET OFFICE, FEDERAL SUBSIDIES AND THE HOUSING GSES 1 (2001).

Washington University Open Scholarship

190 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

Commission (SEC) registration, lower costs for credit ratings, and access

to Treasury Department lines of credit. 177

Perhaps the most important

advantage, however, was the implicit government guarantee. 178

Despite

explicit disclaimers and disclosures stating that the obligations were not

backed by the U.S. government, investor perception—in retrospect,

proven to have been accurate—has always been that the federal

government would bail out Fannie Mae and Freddie Mac in the event of

economic collapse.

2. Government Takeover of Fannie Mae and Freddie Mac

When the then Treasury secretary Henry Paulson went to Congress in

July 2008 seeking authority to take control of Fannie Mae and Freddie

Mac, he claimed that he expected not to use the authority, but hoped that

simply having the authority would restore confidence to the markets. 179

In

response to Paulson‘s request, Congress created the Federal Housing

Finance Agency (FHFA), a new independent GSE regulator with authority

to take control of the housing-related GSEs, if needed, along with

authority to purchase GSE debt and securities and other actions necessary

to restore the GSEs to sound financial condition. 180

Not long thereafter, on September 7, 2008, Secretary Paulson stood

with Jim Lockhart, the director of the new FHFA, to announce that the

FHFA was taking Fannie Mae and Freddie Mac into conservatorship, thus

transferring complete control of the GSEs from the shareholders to the

government. Government ownership, in this instance, was intended to be

temporary, with the conservatorship ending once the corporations returned

to a stable financial condition. Along with the FHFA conservatorship, the

Treasury Department announced that it would: (1) purchase up to $100

billion of senior preferred stock from each of the two entities, with

warrants to purchase up to 79.9% of GSE common stock; (2) purchase

177. In its careful study, the Congressional Budget Office attempted to quantify direct and indirect

federal subsidy benefits to the housing GSEs. Id. at 34; see also CONG. BUDGET OFFICE, CBO‘S

BUDGETARY TREATMENT OF FANNIE MAE AND FREDDIE MAC 10–13 (2010). 178. For a general discussion of the advantages and implicit guarantees related to GSEs, see, for

example, Block, Accounting Scandals, supra note 87, at 435–39; see also infra notes 333–36 and

accompanying text for a discussion of budgetary implications of implicit guarantees. 179. GSE Initiatives: Hearing Before the S. Banking Comm., 110th Cong. 1 (2008) (statement of

Henry M. Paulson, Jr., Secretary, U.S. Treasury).

180. See Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654; see also Oversight Hearing to Examine Recent Treasury & FHFA Actions Regarding the Housing GSEs:

Hearing Before the H. Comm. on Fin. Servs., 110th Cong. 11 (2008) (statement of James B. Lockhart III, Director, Fed. Housing Fin. Agency); MARK JICKLING, CONG. RESEARCH SERV., RS22950,

FANNIE MAE AND FREDDIE MAC IN CONSERVATORSHIP 3–4 (2008).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 191

Fannie Mae and Freddie Mac mortgage-backed securities (MBSs),

essentially ―troubled assets,‖ through the open market; and (3) extend

short-term loans to the GSEs, permitting them to post MBSs as

collateral. 181

At about the same time, additional government intervention

came from the Federal Reserve, which, in November 2008, announced

programs to purchase up to $100 billion in direct obligations of housing-

related GSEs and up to $500 billion in MBSs backed by Fannie Mae,

Freddie Mac, and others. 182

3. Budget Implications of the GSE Takeover and Other Housing-

Related Government Interventions

Federal conservatorship and other government interventions to assist

the housing-related GSEs raise several major questions about how

government interventions on behalf of GSEs should be reflected in the

federal budget. The first concerns the government purchase of GSE equity

interests and government lending to the GSEs. Surely, housing-related

GSE equity acquisitions and lending costs should be reflected in the

budget in the same way that other similar transactions are handled. A

second, and more difficult, question relates to the business operations and

assets and liabilities of the GSEs themselves. Given the magnitude of

special GSE advantages and implicit government guarantees, ongoing

subsidies and potential government costs arguably should have been

incorporated in the federal budget all along. 183

The case for including these

entities on the federal budget becomes stronger, of course, when the

government intervenes to take control. Speaking about this issue before

the Senate Budget Committee, Acting CBO Director, Robert Sunshine,

returned to one of the basic principles expressed in the 1967 President‘s

Commission report: ―[b]orderline agencies and transactions should be

included in the budget unless there are exceptionally persuasive reasons

181. See OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 30, 350–52 (2010).

182. FEDERAL RESERVE 2008 ANNUAL REPORT, supra note 116, at 55–56. The housing-related GSEs also received indirect bailout-type assistance through special tax breaks permitting certain

taxpayers to reflect certain losses on the sales of Fannie Mae and Freddie Mac preferred stock as

ordinary loss. See infra notes 279–82 and accompanying text. 183. JAMES M. BICKLEY, CONG. RESEARCH SERV., RL30346, FEDERAL CREDIT REFORM:

IMPLEMENTATION OF THE CHANGED BUDGETARY TREATMENT OF DIRECT LOANS AND LOAN

GUARANTEES 14–15 (2003) (―[P]roponents argue that credit reform should cover the subsidy costs to taxpayers of GSEs.‖); see also Block, Accounting Scandals, supra note 87, at 438–39; infra notes 333–

36 and accompanying text (discussing budgetary implications of implicit guarantees).

Washington University Open Scholarship

192 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

for exclusion.‖ 184

According to the report, criteria for making this

determination include: (1) the extent to which the government owns an

entity and selects its managers; (2) whether Congress and the President

have control over the entity‘s program and budget; and (3) whether

policies are set to accomplish a broad, public purpose rather than respond

to the interests of private owners. 185

Based upon the ―degree of

management and financial control that the federal government currently

exercises over Fannie Mae and Freddie Mac,‖ the CBO concluded that the

two GSEs should be included in the federal budget. 186

Although the

Obama administration OMB announced plans to include GSEs in future

budgets, it has yet to do so. 187

The question of whether and when to include a particular

nongovernmental business entity‘s finances in the federal budget is not

limited to Fannie Mae and Freddie Mac, however. Such questions might

be raised, for example, with respect to the federal government‘s

unprecedented 2009 day-to-day involvement with the General Motors and

Chrysler corporations. As a condition of receiving federal government

assistance, the two auto companies were required to submit ―viability

plans,‖ which were evaluated by a presidential Task Force on the Auto

Industry. 188

On the one hand, the Task Force was directed ―to avoid

intervening in day-to-day corporate management and refrain from

becoming involved in specific business decisions.‖ 189

At the same time,

however, the Task Force engaged in significant and detailed reviews of

business operations, clearly pressuring the companies to make certain

184. The Budget and Economic Outlook: Fiscal Years 2009 to 2019: Hearing Before the S.

Comm. on the Budget 26 (Jan. 8, 2009) (statement of Robert A. Sunshine, Acting Director, Cong.

Budget Office). 185. Id. (referring to the PRESIDENT‘S COMM‘N ON BUDGET CONCEPTS, REPORT OF THE

PRESIDENT‘S COMMISSION ON BUDGET CONCEPTS (1967)).

186. CONG. BUDGET OFFICE, A PRELIMINARY ANALYSIS OF THE PRESIDENT‘S BUDGET AND AN UPDATE OF CBO‘S BUDGET AND ECONOMIC OUTLOOK 9 (Mar. 2009); see also CONG. BUDGET

OFFICE, CBO‘S BUDGETARY TREATMENT OF FANNIE MAE AND FREDDIE MAC 6–7 (2010).

187. The Obama OMB cited the complexity of making a change of this type in the short time available to complete the budget for fiscal year 2010 as its reason for not making the change

immediately. H. COMM. ON THE BUDGET, SUMMARY AND ANALYSIS OF THE PRESIDENT‘S DETAILED

FISCAL YEAR 2010 BUDGET REQUEST 30 (2009). Although CBO now treats the housing-related GSEs as budgetary, the president‘s 2011 fiscal year budget continues to classify Fannie Mae and Freddie

Mac as nonbudgetary, noting that ―further review of which approach better fits both legal

considerations and goals of budgetary accounting is ongoing.‖ OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL

YEAR 2011, at 140 (2010). 188. CONG. OVERSIGHT PANEL, SEPTEMBER OVERSIGHT REPORT: THE USE OF TARP FUNDS IN

THE SUPPORT AND REORGANIZATION OF THE DOMESTIC AUTOMOTIVE INDUSTRY 10–11 (2009).

189. Id. at 34.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 193

business decisions in exchange for continued government assistance. 190

As

further illustration of the federal government‘s unprecedented

involvement, President Obama announced that the federal government

would ―stand behind‖ Chrysler‘s and General Motors‘s warranties as the

companies went through the restructuring process. 191

When the automobile

manufacturers emerged from bankruptcy later in 2009, the federal

government took an approximately eighty percent equity interest in the

reorganized Chrysler, and an approximately sixty-one percent interest in

the new General Motors. 192

Under the bankruptcy plan, the Treasury

Department is entitled to appoint directors to both corporations. 193

Depending upon the extent of government control and the period of

time over which it will be exercised, individual firms receiving

government assistance should be included in the federal budget. With

respect to the automotive industry, the Treasury Department plans only to

retain the government‘s equity interests ―for a limited period of time‖ and

―to dispose of them ‗as soon as practicable.‘‖ 194

As such, the recent

automotive industry episode may not be one that calls for inclusion of the

individual companies‘ financial information in the federal budget. On the

other hand, a case for budgetary inclusion might arise for future

interventions in the event that the government takes a longer-term equity

or conservatorship interest in a private firm.

Secretary Tim Geithner recently testified on behalf of the Treasury

Department that our financial system has fundamentally failed and needs

―comprehensive reform, not modest repairs at the margin, but new rules of

the game.‖ 195

The Treasury Department‘s subsequent report on financial

reform noted that during a financial crisis, large, interconnected financial

190. As just one example, the Task Force‘s critical assessment of General Motor‘s viability plan,

submitted to meet government-assistance conditions, noted that ―while the Chevy Volt holds promise, it will likely be too expensive to be commercially successful in the short-term.‖ PRESIDENTIAL TASK

FORCE ON THE AUTO INDUSTRY, GM FEBRUARY 17 PLAN: VIABILITY DETERMINATION 1 (Mar. 30,

2009), available at http://www.whitehouse.gov/assets/documents/GM_Viability_Assessment_FINAL. pdf.

191. Barack Obama, U.S. President, Remarks by the President on the American Automotive

Industry (Mar. 30, 2009), available at http://www.whitehouse.gov/the_press_office/Remarks-by-the- President-on-the-American-Automotive-Industry-3/30/09.

192. CONG. OVERSIGHT PANEL, SEPTEMBER OVERSIGHT REPORT: THE USE OF TARP FUNDS IN

THE SUPPORT AND REORGANIZATION OF THE DOMESTIC AUTOMOTIVE INDUSTRY 14, 20 (2009) (reporting equity stake in Chrysler and General Motors, respectively).

193. Id. at 16, 20.

194. Id. at 36. 195. Addressing the Need for Comprehensive Regulatory Reform: Hearing Before the H. Comm.

on Fin. Servs., 111th Cong. 7 (2009) (statement of Timothy Geithner, Secretary, U.S. Dep‘t of the

Treasury).

Washington University Open Scholarship

194 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

companies have faced ―only two untenable options: obtain emergency

funding from the US government . . . , or file for bankruptcy. . . . Neither

of these options is acceptable for managing the resolution of the firm

efficiently and effectively in a manner that limits the systemic risk with

the least cost to the taxpayer.‖ 196

As an alternative, the Obama

administration proposed a ―special resolution regime,‖ including

procedures under which the government could establish a conservatorship

or receivership for a systemically important failing firm. 197

Tools available

to the government under the proposal included ―the ability to stabilize a

failing institution . . . by providing loans to the firm, purchasing assets

from the firm, guaranteeing the liabilities of the firm, or making equity

investments in the firm.‖ 198

Depending on its duration or extent,

government seizure of control or operation of a systemically important

firm surely would raise questions about the budgetary status of the seized

firm.

Although modeled after the administration‘s financial reform report,

the Wall Street Reform Act ultimately enacted by Congress provided more

limited government authority than the original proposal to deal with

financial institutions whose failure would present systemic risk. For

example, the legislation provides that the Corporation [FDIC] 199

―shall, as

receiver . . . , liquidate and wind-up the affairs of a covered financial

company. . . ,‖ 200

and ―shall . . . not take an equity interest in or become a

shareholder of any covered financial company . . . .‖ 201

The question of

whether the assets and liabilities of a failing company under government

receivership belong in the federal budget is less likely to arise to the extent

that the government‘s authority truly is limited to supervising the orderly

liquidation of systemically important financial institutions. The issue

remains important, however, in the context of the housing-related GSE

conservatorships and any other more substantial bailout-type interventions

that might occur outside the scope of the Wall Street Reform Act. In

addition, the budgetary treatment issue might conceivably arise even under

the Wall Street Reform Act in the event that the FDIC uses its authority as

196. U.S. DEP‘T OF THE TREASURY, FINANCIAL REGULATORY REFORM: A NEW FOUNDATION: REBUILDING FINANCIAL SUPERVISION AND REGULATION 76 (2010).

197. Id.

198. Id. at 77. 199. The term ―Corporation‖ is defined by the Act to mean the FDIC. Dodd-Frank Wall Street

Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, § 2(7), 124 Stat. 1376, 1387. 200. Id. § 210(a)(1)(D) (emphasis added).

201. Id. § 206(6).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 195

receiver to transfer assets and liabilities of the failed company to a ―bridge

financial company‖ over which it retains substantial control. 202

A third budgetary concern applicable to the housing-related GSEs, in

particular, but also to government bailout actions more generally, is the

fragmented nature of the interventions. If Congress is to make informed

decisions about future financial assistance or other housing-related GSE

policies, it should have at least a general sense of the aggregate

government resources already devoted to these GSEs. There is no one

place to look for this information. A substantial proportion of the recent

GSE support came from the Federal Reserve, which is entirely ―off-

budget.‖ 203

Additional bailout-type programs were funded by the Treasury

Department, and still others by the Federal Housing Administration. 204

This information is not only fragmented, but may also be difficult to

compare to the extent that different government agencies adopt different

accounting methodologies. 205

In addition to making changes to the Federal

Reserve‘s financial reporting requirements and budget status suggested

above, 206

Congress should work more broadly toward an inclusive budget.

Decisions about whether to include such entities in the budget should not

be left to the individual discretion of different presidential administrations.

Congress should establish clear standards for determining when various

entities should be brought ―on budget.‖ Moreover, Congress should

develop consistent accounting mechanisms to enable more useful

comparisons of various related bailout-type government activities.

202. The FDIC‘s authority as receiver to ―liquidate and wind-up‖ includes the power to transfer

assets of a covered financial company to a bridge financial company. Id. § 210(a)(1)(D). Statutory provisions regarding the charter and establishment of bridge financial companies give the FDIC

signicant control over bridge companies, including appointing of directors, id. § 210(h)(2)(B), specifying terms of the company‘s articles of association, id. § 210(h)(2)(C), authorizing and

providing terms and conditions for the issue of stock or securities, id. § 210(h)(2)(G)(iii), or making

funds available for the bridge company‘s operations, id. § 210(h)(2)(G)(iv). 203. See supra notes 158–65 and accompanying text.

204. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 346–48 (2010). 205. See, e.g., CONG. OVERSIGHT PANEL, NOVEMBER OVERSIGHT REPORT: GUARANTEES AND

CONTINGENT PAYMENTS IN TARP AND RELATED PROGRAMS 11 (2009) (noting the three different

types of budget treatment for the Treasury Department, the Federal Reserve, and the FDIC). 206. See supra notes 174–75 and accompanying text.

Washington University Open Scholarship

196 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

IV. ESTIMATING THE COSTS OF OVERT BAILOUTS

A. Introduction: Budget Accounting for Contingent Risks and Uncertain

Valuations

Whether ―on-budget‖ or ―off-budget,‖ a substantial portion of the

government response to economic crisis has been pursuant to statutes or

regulations that overtly authorize particular types of federal bailout

expenditures. Overt authorization occurs where there is a formal

government program explicitly designed to provide assistance to failing

businesses or to prevent economic failure or collapse. In this sense, an

overt program still might be ―off-budget,‖ or details of its operation or

finances otherwise might not be fully transparent. A government program

is overt simply if it serves an express bailout-type function. Some overt

programs are more transparent than others. Media headlines and public

conversation about massive bailouts tend to focus on dollar amounts

authorized by recent legislation, such as the $700 billion in TARP funds

authorized by EESA. 207

Countless other federal programs, including the

various Federal Reserve initiatives discussed earlier, also provided bailout-

type relief. 208

As one commentator noted, ―TARP is massive, but it gets

disproportionate attention relative to the size of other government

programs that did not require legislation. It is just one part of a

governmentwide [sic] effort to support and stabilize the financial

system.‖ 209

Assessing the true costs of even the most overt government bailout

interventions is far more complex than a simple tally of total

disbursements from the federal fisc. Borrowers may not repay amounts

received as direct government loans, and the government may not

ultimately be obliged to make payments pursuant to loan guarantee

programs. Also, the government might lose with respect to its equity or

troubled asset investments in connection with particular failing companies.

Risk levels vary dramatically for different types of loan and investment

programs and vary from borrower to borrower or investment to

investment. The sections that follow explore the budget accounting

challenges presented by various types of government economic

intervention.

207. See supra notes 28–31 and accompanying text. 208. See supra notes 105–29 and accompanying text.

209. Lee A. Sheppard & Martin A. Sullivan, Taxing Financial Pollution, 2010 TAX NOTES 697,

699 (Feb. 8, 2010).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 197

B. Direct Loans, Loan Guarantees, and Other Contingent Liabilities

1. Federal Government Loan and Insurance Programs

The federal government routinely operates numerous direct federal

loan and loan guarantee programs, included among them several designed

to assist students, 210

small businesses, 211

rural utility services, 212

and home

buyers. 213

In addition, the federal government provides federal bank

deposit insurance, along with a number of other federal insurance

programs. 214

One common government response to economic crisis is to

increase authority for already existing direct loan, loan guarantee, or

insurance programs, or to create new ones. Such actions made up the bulk

of the government‘s response to the 2008–2009 economic crisis. One

feature of the recent EESA bailout legislation, for example, was an

increase in the insurance coverage cap from $100,000 to $250,000 for

accounts maintained at FDIC-insured depository institutions. 215

More

210. The federal government began its direct student loan programs with the National Defense Education Act of 1958, Pub. L. No. 85-864, § 201, 72 Stat. 1580, 1583. For the current direct loan

programs, see 20 U.S.C. §§ 1087a–1087j (2006) (William D. Ford Federal Direct Loan Program); 20 U.S.C. §§ 1087aa–1087vv (2006) (need-based federal Perkins loans). Federal student loan guarantees

and federal student loan insurance programs began with the Higher Education Act of 1965, Pub. L.

No. 89-329, § 421, 79 Stat. 1219, 1236. For the current student loan guarantee and insurance programs, see 20 U.S.C. § 1071 (2006) (Robert T. Stafford Federal Student Loan Program).

211. The Small Business Administration (SBA), created by the Small Business Act, Pub. L. No.

85-536, 72 Stat. 384 (1958), has authority to extend direct loans and loan guarantees to qualified small businesses. Id. § 7. For current SBA loan authority, see, for example, 15 U.S.C. § 636 (2006) (―loans

to small business concerns‖).

212. The Department of Agriculture was empowered, for example, to extend loans to develop electrical and telephone infrastructure in rural areas. Rural Electrification Act of 1936, Pub. L. No. 74-

605, 49 Stat. 1363 (codified as amended at 7 U.S.C. §§ 902–950aaa (2006)).

213. Eligible home buyers may receive federally guaranteed mortgages through the Federal

Housing Administration (FHA). See 12 U.S.C. §§ 1707–1715 (2006); OFFICE OF MGMT. & BUDGET,

EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT

FISCAL YEAR 2011, at 346 (2010). In addition to the FHA, Congress created GSEs Fannie Mae and Freddie Mac to provide guarantees on mortgage-backed securities. See supra notes 175–78 and

accompanying text.

214. The Federal Deposit Insurance Corporation (FDIC), established by the Banking Act of 1933, Pub. L. No. 73-66, 48 Stat. 162, provides insurance for accounts maintained at insured depository

institutions. 12 U.S.C. § 1821 (2006). See also Agricultural Adjustment Act of 1938, Pub. L. No. 75-

430, tit. V, 52 Stat. 1938 (1956) (Federal Crop Insurance Act) (codified at 7 U.S.C. §§ 1501–1524 (2006)); Federal Flood Insurance Act of 1956, Pub. L. No. 84-1016, 70 Stat. 1078 (codified at 42

U.S.C. §§ 4001–4129 (2006)).

215. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 136, 122 Stat. 3765, 3799 (to be codified at 12 U.S.C. §§ 5201–5261). Although the increase was originally scheduled to

expire at the end of 2009, the $250,000 coverage amount was extended through the end of 2013,

Helping Families Save Their Homes Act of 2009, Pub. L. No. 111-22, § 204(a)(1), 123 Stat. 1632, 1648–49, and later made permanent by the Dodd-Frank Wall Street Reform and Consumer Protection

Washington University Open Scholarship

198 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

significantly, much of the recent bailout response involved new loan, loan

guarantee, and other similar programs. Several of these recent programs

technically took the form of government purchases of preferred stock or

other equity interests in exchange for capital infusions from the

government. 216

For purposes of assessing bailout cost, however, these

federal purchases can be viewed as loan-type transactions. In most cases,

the government did not mean to take a long-term shareholder interest, but

intended to sell its equity stake back to the firms receiving the capital as

soon as it was financially prudent for the firms to redeem or repurchase the

stock or warrants. The firms‘ redemption or repurchase of government-

held equity is essentially equivalent to repayment of a government loan. 217

In several cases, the government profited when participating corporations

repurchased their own equity at a higher price than the capital initially

contributed by the government. As noted by the OFS, ―disposition of

warrants has succeeded in significantly increasing taxpayer returns on the

CPP preferred investments that have been repaid. As of December 31,

2009, Treasury has received $4 billion in gross proceeds on the disposition

of warrants in 34 banks . . . .‖ 218

2. Cash v. Accrual Accounting for Loans and Other Credit Programs

Before the Federal Credit Reform Act (FCRA) of 1990, 219

the federal

budget generally recorded expenditures for federal credit programs using a

cash method of accounting. Under this method, expenditures are recorded

for the budget year in which funds are paid out, and income is recorded for

the budget year in which funds are received. 220

Thus, a direct government

loan was reflected as cost when funds were disbursed, even if it was likely

Act of 2010, Pub. L. No. 111-203, § 335, 124 Stat. 1376, 1540 (to be codified as amended at 12 U.S.C.

§ 1821(a)(1)(E)). 216. For example, the TARP Capital Purchase Program (CPP) and Targeted Investment Program

(TIP) were equity investment programs.

217. See CONG. OVERSIGHT PANEL, JULY OVERSIGHT REPORT: TARP REPAYMENTS, INCLUDING THE REPURCHASE OF STOCK WARRANTS 10 (2009) (―In the same way that loans are repaid, preferred

shares are ‗redeemed‘ by the institution paying back the ‗liquidation‘ amount of the shares, equivalent

to the principal amount of a loan.‖). 218. OFFICE OF FIN. STABILITY, U.S. DEP‘T OF THE TREASURY, WARRANT DISPOSITION REPORT 1

(2009).

219. Federal Credit Reform Act of 1990, Pub. L. No. 101-508, 104 Stat. 1388 (codified at 2 U.S.C. § 661 (2006)).

220. U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO-05-734SP, A GLOSSARY OF TERMS USED IN

THE FEDERAL BUDGET PROCESS 27–28 (2005) (defining cash method as a ―system of accounting in which revenues are recorded when cash is actually received and expenses are recorded when payment

is made without regard to the accounting period in which the revenues were earned or costs were

incurred‖).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 199

to be repaid. On the other hand, even if the borrower was likely to default,

a government loan guarantee did not appear as budget cost until the

borrower defaulted and the government was actually required to make

good on the guarantee. As a result, direct government loan budget costs

were overstated, and loan guarantee costs were understated. Moreover, the

apparently lower price tag for loan guarantees created a policy bias in

favor of guarantee over direct loan programs, without genuine policy

consideration of the advantages and disadvantages of the different

approaches.

Concern over these budgetary distortions led Congress to adopt FCRA,

which requires accrual accounting for most direct loan and loan guarantee

programs. 221

Under this method, the value of a loan or loan guarantee is

determined first by estimating all expected cash inflows and outflows for

the duration of the transaction. Those projections are then consolidated

and expressed as a single figure, using present-value calculations.

Computing present value requires use of an interestor discountrate to

determine the value today of an expected future payment or the amount

that must be set aside today in order to meet a future obligation. 222

Most would probably agree that accrual-basis reforms mandated by

FCRA have improved the accuracy of federal budget reporting for loans

and loan guarantees. 223

Still, some accuracy and consistency issues remain.

First, FCRA was not comprehensive in its scope. Although most credit

programs now are governed by accrual accounting rules, the statute

explicitly exempts entitlement programs and credit programs of the

Commodity Credit Corporation. 224

In addition, FCRA does not apply to

credit or insurance activities of the FDIC and certain other deposit

insurance programs. 225

In the end, different budget accounting rules may

221. 2 U.S.C. § 661a(5)(A) (2006) (defining ―cost‖ to mean ―the estimated long-term cost to the

Government of a direct loan or loan guarantee or modification thereof, calculated on a net present

value basis, excluding administrative costs . . . .‖) (emphasis added). The President is directed to include such costs of direct loans and guarantees, along with planned levels of new loan obligations or

guarantees, in the President‘s annual budget. Id. § 661c(a).

222. For a simple description and example, see CONG. BUDGET OFFICE, ESTIMATING THE VALUE OF SUBSIDIES FOR FEDERAL LOANS AND LOAN GUARANTEES 2 n.4 (2004).

223. See, e.g., id. at 2 (―[C]redit-reform accounting provides more useful cost estimates than did

the cash-basis accounting it replaced. The current approach is forward looking for the life of the loan; it accounts for the time value of money; and it generally assigns the same budgetary cost to equivalent

loans and loan guarantees.‖).

224. 2 U.S.C. § 661c(c) (2006). 225. 2 U.S.C. § 661e(a) (2006) (exempting the FDIC, along with the ―National Credit Union

Administration, Resolution Trust Corporation, Pension Benefit Guaranty Corporation, National Flood

Insurance, National Insurance Development Fund, Crop Insurance, [and] Tennessee Valley Authority‖). The CBO was directed to study and report back to Congress on whether federal deposit

Washington University Open Scholarship

200 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

apply depending on the particular agency source of the federal lending or

guarantee activity. Federal Reserve loan-related activities are generally

entirely ―off-budget.‖ 226

Moreover, even though all Treasury Department

programs are governed by FCRA‘s accrual reporting requirements, TARP

expenditures that are used for some Treasury Department bailout-type

interventions are subject to special risk-based accounting rules that do not

apply to other Treasury Department expenditures. 227

On the other hand,

FDIC bailout-type actions are reported for budget purposes through cash-

method accounting. 228

At a minimum, these different approaches create consistency problems,

making it difficult to compare the budget consequences of lending

activities undertaken by different government agencies. In turn, these

difficulties complicate policy choices regarding the most efficient use and

source of government loans and guarantees.

A second remaining potential accuracy and consistency problem under

FCRA relates to setting an appropriate interest or discount rate to compute

net present value. Although the concept of discounting to net present value

is straightforward, choosing the appropriate rate requires insight into

future general economic conditions and market risk. FCRA explicitly

resolves the issue by requiring use of ―the average interest rate on

marketable Treasury securities of similar maturity to the cash flows of the

direct loan or loan guarantee for which the estimate is being made.‖ 229

These FCRA present-value calculations, based upon risk-free Treasury

security rates, differ from those used by private lenders in that the

government estimates ―exclude the cost of market risk—the compensation

that investors require for the uncertainty of expected but risky cash

flows.‖ 230

Critics charge that the effect of using Treasury rates, rather than market

risk-based rates, to calculate net present value ―is to overstate the value of

insurance programs should use similar accrual accounting methods for budget purposes. 2 U.S.C.

§ 661e(b). In its report, CBO was critical of existing federal budget accounting for deposit insurance

programs, but noted both advantages and disadvantages to switching to accrual budget accounting. CONG. BUDGET OFFICE, BUDGETARY TREATMENT OF DEPOSIT INSURANCE: A FRAMEWORK FOR

REFORM, at x–xiii (1991).

226. See supra notes 158–74 and accompanying text. 227. See infra notes 233–36 and accompanying text.

228. CONG. OVERSIGHT PANEL, NOVEMBER OVERSIGHT REPORT: GUARANTEES AND

CONTINGENT PAYMENTS IN TARP AND RELATED PROGRAMS 11 (2009) (noting the three different types of budget treatment for the Treasury Department, the Federal Reserve, and the FDIC).

229. 2 U.S.C. § 661a(5)(E) (2006).

230. CONG. BUDGET OFFICE, ESTIMATING THE VALUE OF SUBSIDIES FOR FEDERAL LOANS AND LOAN GUARANTEES 1–2 (2004).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 201

federal direct loans and understate the value of government guarantees,

relative to the price that would be observed in competitive financial

markets.‖ 231

A CBO study of the issue reached a similar conclusion:

[I]gnoring the cost of risk understates the federal cost of credit

assistance, potentially biasing the allocation of budgetary resources.

For example, excluding the cost of risk from budget and program

decisions may mislead policymakers by suggesting that some

federal credit programs provide financial resources to the

government at no cost to taxpayers. It also encourages reliance on

credit rather than other policies that might be more efficient in

achieving particular goals. 232

3. TARP, Credit Reform, and Asset Valuation

Substantive legislation often fails to include details on how to reflect

programmatic expenses and revenues in the budget. Congress was explicit

in EESA, however, when it required that ―the costs of purchases of

troubled assets . . . and guarantees of troubled assets . . . , and any cash

flows associated with [various authorized TARP activities] shall be

determined as provided under the Federal Credit Reform Act of 1990.‖ 233

In other words, budget accounting for TARP programs must be done on an

accrual rather than a cash-flow basis. More specifically, Congress

responded to FCRA critics by explicitly requiring that discount rate

calculations used to determine net present value for EESA purposes be

adjusted for market risk. 234

In other words, Congress instructed the

Treasury Department not to use Treasury rates, but instead to use a ―new

and improved‖ FCRA accounting method with respect to TARP

activities. 235

Assuming that the risk-based discount rates utilized are

231. Deborah Lucas & Marvin Phaup, Reforming Credit Reform, 28 PUB. BUDGETING & FIN. 90,

91 (2008).

232. CONG. BUDGET OFFICE, ESTIMATING THE VALUE OF SUBSIDIES FOR FEDERAL LOANS AND LOAN GUARANTEES 2–3 (2004).

233. Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 123(a), 122 Stat.

3765, 3790 (to be codified at 12 U.S.C. §§ 5201–5261). 234. Id. § 123(b)(1) (―[T]he cost of troubled assets and guarantees of troubled assets shall be

calculated by adjusting the discount rate in . . . 2 U.S.C. § 661a(5)(E) for market risks.‖).

235. The Bush administration initially took the position that EESA‘s statutory reference to the Credit Reform Act applied only to direct loans and loan guarantees and thus budgeted for other types

of TARP disbursements using the cash method. The CBO, in contrast, computed net present value

costs for all TARP activities. CONG. BUDGET OFFICE, THE TROUBLED ASSET RELIEF PROGRAM: REPORT ON TRANSACTIONS THROUGH DECEMBER 31, 2008, at 4 (2009) (contrasting OMB and CBO

Washington University Open Scholarship

202 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

reasonably accurate, the new and improved TARP accrual reporting

should provide a more accurate picture of long-term budgetary costs.

Despite EESA‘s statutory emphasis on acquiring troubled assets, the

Treasury Department quickly ―abandoned its original strategy of

purchasing ‗troubled‘ mortgage and other assets from the nation‘s

financial institutions, deciding instead to invest money directly into those

institutions.‖ 236

In most cases, the government transferred cash to

struggling financial institutions in exchange for equity interestsin the

form of preferred stock and warrantsthat were specifically tailored for

the TARP program and for which there was no public market. Thus,

TARP‘s net-present-value approach to valuing assets is relevant not just

for budget purposes. Before considering budget reporting issues, the

Treasury Department needed to use net-present-value judgments to

determine the appropriate price to pay for various equity interests.

One of the largest TARP programs was the Capital Purchase Program

(CPP), through which the Treasury Department purchased senior preferred

equity and subordinated debentures. 237

According to the Treasury

Department, this program was designed to ―directly infuse capital into

healthy, viable banks with the goal of increasing the flow of financing

available to small businesses and consumers.‖ 238

In addition to programs

designed to ensure the stability of otherwise healthy financial institutions

in a down economy, the Treasury Department created similar programs to

invest in struggling businesses. Through the Systemically Significant

Failing Institutions program, for example, the government purchased ten

percent of senior preferred AIG stock in order to provide needed capital to

the ailing insurance giant. 239

accounting). The Obama administration has since adopted CBO‘s net-present-value accounting for all

TARP activities. 236. CONG. OVERSIGHT PANEL, FEBRUARY OVERSIGHT REPORT: VALUING TREASURY‘S

ACQUISITIONS 4 (2009). 237. OFFICE OF FIN. STABILITY, U.S. DEP‘T OF THE TREASURY, AGENCY FINANCIAL REPORT:

FISCAL YEAR 2009, at 14–15 (2009).

238. Press Release, U.S. Dep‘t of the Treasury, Treasury Provides Funding to Bolster Healthy, Local Banks: Capital Purchase Program Funds 23 Banks to Help Meet Lending Needs of Local

Consumers, Businesses (Jan. 27, 2009), available at http://www.ustreas.gov/press/releases/tg03.htm.

At about the same time, the Treasury Department also created the Targeted Investor Program (TIP), designed to provide funding to large financial institutions thought to be systemically important to

financial system functioning. Press Release, U.S. Dep‘t of the Treasury, Treasury Releases Guidelines

for Targeted Investment Program (Jan. 2, 2009), available at http://www.ustreas.gov/press/releases/ hp1338.htm. This program apparently was focused on Citigroup. See id.

239. U.S. DEP‘T OF THE TREASURY, TARP AIG SSFI INVESTMENT SENIOR PREFERRED STOCK

AND WARRANT: SUMMARY OF SENIOR PREFERRED TERMS (2008), available at http://www.ustreas. gov/press/releases/reports/111008aigtermsheet.pdf (last visited May 15, 2010). See also supra note 32

and accompanying text.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 203

As mandated by EESA, the Treasury Department is required to use

risk-based net-present-value accounting for valuing these purchases. But

conceptualizing risk-based net-present-value discounting is far easier than

implementing it. Ideally, each investment should be carefully analyzed on

a case-by-case basis, taking into account specific details about default and

other risks with respect the particular investment. The congressional

oversight panel established to conduct monthly reviews of Treasury

Department activity under the TARP program recently reported that the

―Treasury paid substantially more for the assets it purchased under the

TARP than their then-current market value.‖ Instead of a case-by-case

analysis, the Treasury Department adopted a ―one-size-fits-all investment

policy,‖ 240

making equity investments on similar terms in both so-called

―healthy‖ and ―weaker institutions.‖ 241

One particular concern with a

―one-size-fits-all‖ approach is that it creates differential subsidy rates. In

one report, for example, CBO estimated a seventy-three percent subsidy

for auto-related government assistance, but only a two percent subsidy for

bailout transactions with certain financial institutions. 242

In addition, by

some estimates, the cost of assistance to AIG per dollar committed was

double the cost of similar support to Citigroup. 243

The Treasury

Department might defend itself, in part, by arguing that the government

ultimately profited from many of its TARP investments. Under these

circumstances, however, one might question how much more profit the

government would have earned if it had not overpaid for many of these

investments. This question is all the more apt when the country is facing

such extraordinary federal deficits. Differential subsidy rates are not

necessarily wrong as a policy matter. The problem with the current

approach is that subsidy differences do not appear to be the result of

measured policy judgments, but instead an almost accidental outcome of

different accounting methodologies used for different government

programs and a one-size-fits-all approach to valuation for very different

transactions within the same programs.

Congress must refine its budget accounting by using market-risk

analysis to more systematically compute net present value. To do this,

Congress could establish an independent valuation entity with expertise in

240. CONG. OVERSIGHT PANEL, FEBRUARY OVERSIGHT REPORT: VALUING TREASURY‘S

ACQUISITIONS 2 (2009).

241. Id. at 8. 242. CONG. BUDGET OFFICE, THE TROUBLED ASSET RELIEF PROGRAM: REPORT ON

TRANSACTIONS THROUGH JUNE 17, 2009, at 3–4 (2009).

243. ELLIOTT, supra note 21, at 4 (referring to CBO report).

Washington University Open Scholarship

204 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

market-based risk assessment. To make informed decisions about the most

efficient allocation of bailout resources, Congress must be able to compare

the extent to which different government interventions involve different

―subsidy rates.‖

Another significant problem may simply be that some valuations are

just fuzzier or more uncertain than others. Congress must give up the

―illusion of precision‖ 244

and instead work within confidence ranges, or at

least indicate some measure of the degree of certainty behind particular

valuations. Alternatively, budget accounts might isolate the more

uncertain figures into a separate set of accounts.

4. Mission Fragmentation

Many of the government‘s 2008–2009 interventions were

―combination bailouts,‖ 245

or joint efforts involving the cooperation of

multiple agencies in the same program. 246

When so many different

agencies are simultaneously engaged in similar types of bailout-like

interventions, fragmentation can make it difficult to absorb even

information that is reflected in the budget. For one thing, the information

for each agency appears in separate agency accounts and may be difficult

to consolidate. 247

Second, agencies use different methods of accounting,

making it difficult to compare and assess the efficiency of one program

over another. 248

Non-TARP credit programs governed by FCRA use

accrual-method accounting, but are not required to use market-risk-based

discount rates. On the other hand, TARP-based Treasury Department

programs are directed to use the new and improved market-risk-based

discount rates. 249

This can lead to odd results given that a significant

portion of the Treasury Department‘s bailout intervention was not under

the TARP umbrella. Similar bailout-type programs, even within the same

agency, may reflect different methods of accounting. For example, when

244. Michael J. Graetz, Paint-by-Numbers Tax Lawmaking, 95 COLUM. L. REV. 609, 613 (1995).

245. See supra notes 81–84 and accompanying text.

246. See supra notes 83–84, 128–29 and accompanying text. 247. Mission fragmentation is certainly not limited to bailout programs. Then comptroller general

David Walker testified about ―widespread mission fragmentation and program overlap throughout

major mission areas at the federal level. . . . Even more broadly, many missions are characterized by the presence of multiple tools, such as tax expenditures, grants, loans, and direct federal spending

programs.‖ The Office of Management and Budget: Is OMB Fulfilling Its Mission?: Hearing Before

the Subcomm. on Gov’t Mgmt., Info. and Tech. of the H. Comm. on Gov’t Reform, 106th Cong. 75 (2000) (prepared statement of David M. Walker, U.S. Comptroller Gen.).

248. See supra notes 223–28 and accompanying text. 249. See supra notes 233–43 and accompanying text.

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 205

asked to report on a proposed $34 billion bridge loan to the auto industry,

CBO estimated only a fifty percent subsidy rate for a non-TARP program,

but a seventy percent subsidy rate for the same loan under TARP because

the latter ―program‘s accounting requires an adjustment to reflect market

risk.‖ 250

The extent to which government bailout interventions can be

fragmented is further illustrated by actions taken by the FDIC during the

2008–2009 economic crisis. Unlike Fannie Mae and Freddie Mac, the

FDIC is a government-owned independent agency, established by the

Banking Act of 1933 to insure bank deposits. 251

Hence, the FDIC is an

―on-budget‖ agency. Like the Federal Reserve, 252

the FDIC has

authority—albeit infrequently used—to take certain emergency actions to

avoid or mitigate systemic risk. 253

Just weeks after Congress passed its

substantial EESA bailout package, the FDIC announced its own

Temporary Liquidity Guarantee Program, under which it would guarantee

senior unsecured debt instruments. 254

According to presidential budget

documents, this was the first time that the FDIC guaranteed bank and bank

holding company debt. 255

Since the authority for these FDIC actions did

not come from the TARP legislation, the FDIC is not statutorily bound to

use risk-based accrual accounting. In fact, the FDIC is not governed at all

by the accrual-reporting FRCA requirements. 256

As reported by the TARP

Oversight Committee, ―[o]nly the cash flows associated with the FDIC

guarantees are reflected in the federal budget, not the discounted present

value of those flows. This means that no ‗cost‘ is recorded for the FDIC

250. Letter from Robert A. Sunshine, Acting Dir., Cong. Budget Office, to John M. Spratt, Chair,

Comm. on the Budget, U.S. House of Representatives (Dec. 5, 2008).

251. Pub. L. No. 73-66, 48 Stat. 162 (1933) (codified at 12 U.S.C. § 1811 (2006)). 252. See supra notes 111–14 and accompanying text.

253. 12 U.S.C. § 1823(c)(4)(G) (2006).

254. Temporary Liquidity Guarantee Program, 12 C.F.R. § 370 (2008); see also DARRYL E. GETTER & OSCAR R. GONZALES, CONG. RESEARCH SERV., R40413, THE FEDERAL DEPOSIT

INSURANCE CORPORATION (FDIC): EFFORTS TO SUPPORT FINANCIAL AND HOUSING MARKETS 4–5

(2009); FED. DEPOSIT INS. CORP., 2008 ANNUAL REPORT 25–26 (2009). 255. OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL

PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL YEAR 2011, at 28 (2010). The FDIC also

participated with the Treasury Department and Federal Reserve in providing assistance to Citigroup and Bank of America. See CONG. OVERSIGHT PANEL, NOVEMBER 2009 OVERSIGHT REPORT:

GUARANTEES AND CONTINGENT PAYMENTS IN TARP AND RELATED PROGRAMS 16–20 (2009); see

also DARRYL E. GETTER & OSCAR R. GONZALES, CONG. RESEARCH SERV., R40413, THE FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC): EFFORTS TO SUPPORT FINANCIAL AND HOUSING

MARKETS 6 (2009) (describing joint Public-Private Investment Fund (PPIF) with the U.S. Treasury and the Federal Reserve).

256. 2 U.S.C. § 661(e)(a) (2006); see also supra notes 224–25 and accompanying text.

Washington University Open Scholarship

206 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

guarantees . . . unless there is an actual default and payment of a guarantee

. . . .‖ 257

In sum, Federal Reserve actions do not appear at all in the budget,

TARP transactions may use different types of accrual-accounting

methodologies, and the FDIC uses cash-method budget accounting. 258

These inconsistencies are especially troubling when different agencies are

cooperating in joint administration of the same bailout program.

Congress should consolidate the authority and budget reporting

requirements for bailout-like interventions and, to the extent possible,

make all such intervention ―on-budget.‖ Adding to the fragmentation

problem, many bailout-type programs are delivered through the tax system

in the form of special exclusions, deductions, or credits. 259

The costs

incurred as a result of revenue lost from these provisions are not included

in the regular budget. 260

As one Government Accounting Office report

observed, ―mission fragmentation and program overlap can create an

environment in which programs do not serve participants as efficiently and

effectively as possible. Like spending programs, tax expenditures may

reduce government effectiveness to the extent that they duplicate or

interfere with other federal programs.‖ 261

The sections that follow consider

the potentially hidden costs of various tax-related and other more ―covert‖

bailout-type government activities.

V. ESTIMATING THE COSTS OF COVERT OR HIDDEN BAILOUTS

A. Relief Through Tax Expenditures

1. In General

In times of economic stress, government assistance can be provided

through indirect payments in the form of temporary tax exclusions,

deferrals, deductions, or credits, sometimes referred to as ―tax

257. CONG. OVERSIGHT PANEL, NOVEMBER 2009 OVERSIGHT REPORT: GUARANTEES AND

CONTINGENT PAYMENTS IN TARP AND RELATED PROGRAMS 11 (2009). 258. As the TARP oversight panel observes, ―[f]rom a consolidated, government-wide

perspective, the federal budget treats the guarantee transactions of the three agencies in three different

ways.‖ CONG. OVERSIGHT PANEL, NOVEMBER 2009 OVERSIGHT REPORT: GUARANTEES AND CONTINGENT PAYMENTS IN TARP AND RELATED PROGRAMS 11 (2009).

259. See infra notes 266–82 and accompanying text.

260. See infra notes 264–65 and accompanying text. 261. U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO-05-690, GOVERNMENT PERFORMANCE AND

ACCOUNTABILITY: TAX EXPENDITURES REPRESENT A SUBSTANTIAL FEDERAL COMMITMENT AND

NEED TO BE REEXAMINED 51 (2005).

https://openscholarship.wustl.edu/law_lawreview/vol88/iss1/3

2010] MEASURING THE TRUE COST OF GOVERNMENT BAILOUT 207

expenditures.‖ 262

In addition to direct spending legislation, Congress often

turns to this tax-expenditure toolbox to provide bailout-type relief. Any

reduction in tax liability to the struggling business is revenue foregone to

the federal fisc and thus a cost imposed upon general taxpayers. It is well

accepted that special tax deductions, credits, exclusions, and deferrals that

reduce government receipts generate real budget costs that can be

measured in estimated foregone revenue. 263

Since 1974, federal budget

rules have required that the president‘s budget and the congressional

budget resolution include such estimates of revenue foregone as a result of

tax expenditures. 264

Accordingly, some tax expenditure data is available.

Still, this information is not otherwise incorporated into the federal

budget. 265

A true measure of aggregate costs demands better budgetary

incorporation of bailout-type costs incurred through tax expenditures. The

sections that follow offer illustrations of substantial government bailout-

type intervention through tax expenditures that are not reflected in the

regular budget.

2. Net Operating Loss (NOL) Carryovers: Internal Revenue Code

§ 172

One tax-expenditure approach to providing bailout-type relief is to

extend business taxpayers‘ ability to deduct losses for federal income tax

purposes beyond what would otherwise be permitted. In general, business

taxpayers are entitled to deduct all of their ordinary and necessary business

262. The concept of a ―tax expenditure budget‖ is generally first attributed to Professor Stanley Surrey. STANLEY S. SURREY, PATHWAYS TO TAX REFORM: THE CONCEPT OF TAX EXPENDITURES 1–

14 (1973); STANLEY S. SURREY & PAUL R. MCDANIEL, TAX EXPENDITURES 1–6 (1985). For

additional sources on tax expenditures in general, see Victor Thuronyi, Tax Expenditures: A

Reassessment, 1988 DUKE L.J. 1155 (1988). For a more recent and excellent account of the tax

expenditure budget and the relationship between taxing and spending programs, see David A.

Weisbach & Jacob Nussim, The Integration of Tax and Spending Programs, 113 YALE L.J. 955 (2004). 263. See sources cited supra note 262.

264. Congressional Budget and Impoundment Control Act of 1974, Pub. L. No. 93-344, § 3, 88

Stat. 297, 299 (codified in part at 2 U.S.C. § 632(e)(2)(E) (2006)) (defining ―tax expenditure‖ as ―revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion,

exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax,

or a deferral of tax liability‖). The Joint Committee on Taxation regularly publishes estimates on tax expenditure costs. See, e.g., STAFF OF THE J. COMM. ON TAXATION, 109TH CONG., ESTIMATES OF

FEDERAL TAX EXPENDITURES FOR FISCAL YEARS 2006–2010 (Comm. Print 2006). The President‘s

annual budget also includes tax expenditure estimates. See OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE U.S. GOVERNMENT FISCAL

YEAR 2011, at 207–23 (2010).

265. U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO-05-690, GOVERNMENT PERFORMANCE AND ACCOUNTABILITY: TAX EXPENDITURES REPRESENT A SUBSTANTIAL FEDERAL COMMITMENT AND

NEED TO BE REEXAMINED (2005).

Washington University Open Scholarship

208 WASHINGTON UNIVERSITY LAW REVIEW [VOL. 88:149

expenses from their gross receipts. 266

For businesses suffering a net loss,

however, the government does not issue refunds. The tax return of a ―loss

business‖ simply reports an overall net loss and does not reflect any tax

liability. In other words, a business with a net loss cannot ―use‖ its loss for

beneficial tax purposes in the taxable year in which the loss was incurred.

Absent special rules permitting taxpayers to carry such a loss back to

offset income from a prior year‘s tax return or forward to offset income on

a future year‘s return, taxpayers would be denied the opportunity to ever

deduct losses resulting from their ―net loss‖ years. 267

Fortunately for

taxpayers, Congress has adopted special NOL carryover rules, which

generally authorize taxpayers to carry net operating losses back to two

preceding taxable years and forward to twenty subsequent years. 268