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The ratings agency Standard & Poor's yesterday described the profound risks Congress, the Bush Administration, and the Federal Reserve are creating by expanding the role of the GSE's and through expanded Fed lending to financial institutions. Reuters reports:
In a deep and prolonged recession, the maximum potential cost of assisting the GSEs, together with loans and guarantees extended by U.S. government agencies, yields a potential fiscal cost to the government of up to 10 percent of GDP, S&P said in a statement.
The recent rescue of ailing Bear Stearns highlighted the potential risks associated with supporting the broker-dealer segment of the U.S. financial system, S&P said, adding that the GSEs pose a far greater fiscal risk to the government's rating.
Ten percent of GDP is about $1.4 trillion dollars. That's a mind-numbing level of fiscal risk for taxpayers-- we would have to double every American's income tax payment this year to meet it. That's an especially unsettling thought on Tax Day.
How this crisis will work: the federal government piles all of the bad mortgages and other risky assets into the GSE's (Fannie Mae and Freddie Mac), the FHA, the FHLBs, and onto the Federal Reserve balance sheet. If the economy doesn't rebound (a "deep and prolonged recession") the GSE's will flounder, and the government will intervene directly. Indeed, as part of the Bear Stearns deal, taxpayers already have billions in exposure to GSE-backed assets. Meanwhile, the Fed's "temporary" lending window becomes permanent as major banks become insolvent. At some point, the Fed will have to mark down and liquidate the questionable assets they are taking as collateral.
Of course, this scenario will hopefully never come to pass. But our government is playing a reckless and irresponsible game of brinksmanship.