How Bailout Deal Will Impact Next President

By Beacon Staff

While rarely in Washington, presidential contenders John McCain and Barack Obama are keeping a close eye on the massive rescue of US financial markets working its way through Congress.

One reason: As president, one or the other will have to live with its outcomes.

But neither candidate expects to have to lop $700 billion – the expected level of funding for the plan – off their presidential wish lists – and experts say they may be right, at least in the short term.

Asked in their first presidential debate in Oxford, Miss., on Friday what each would give up to pay for the rescue plan, neither candidate offered up anything cherished.

Senator McCain, the Republican nominee, said he’d cut pork barrel projects, slash ethanol subsidies, terminate cost-plus defense contracts, freeze non-Defense and non-Veterans Affairs discretionary spending, and “scrub every agency of government.” But for the freeze, these are all positions he has advanced in the past.

Senator Obama, the Democratic nominee, said that “there are going to be things that end up having to be deferred and delayed,” but added that they would not be investments in energy independence, health care, education, or infrastructure – his top four priorities.

Pressed by moderator Jim Lehrer to name something specific he would be willing to give up, Obama proposed axing $15 billion in Medicare subsidies to private insurers – a GOP program.

So, why doesn’t a $700 billion program mean $700 billion less for a new president to spend? The answer lies in accounting conventions that are often misunderstood – and, critics would add, not well suited to the nation’s current financial crisis.

“People will find it hard to believe, but the bailout will have very little impact on the budget or the deficit,” says Peter Morici, a business professor at the University of Maryland and the former chief economist at the US International Grade Commission.

What the government is going to do is to sell bonds, get cash and use that cash to buy mortgage-backed bonds originally created by the banks. These bonds will be purchased at a discount and the government will hold them to maturity, says Mr. Morici.

“If the government loses any money, it will be because it overpaid for the bonds – and in any case, the budgetary impact is not large,” he adds. “It will be stretched out over several years.

The House Budget Committee tried to get a handle on this issue in a hearing last week with the Congressional Budget Office.

“We are concerned that the proposal in its original form did not adequately account for market risk and, therefore, understated costs,” said Rep. John Spratt (D) of South Carolina, who chairs the panel, at a Sept. 24 hearing.

“As you can see, the customary accounting conventions are not an easy fit for the circumstances we find ourselves in. Yet, the convention used can have a major impact on how the request for $700 billion gets incorporated into the budget,” he added.

Here’s how CBO director Peter Orszag explained how the expected costs of the proposed rescue plan will be calculated: If the government buys an asset for $1 in a liquid market where there is competitive bidding, there is zero net gain or net loss at that point. “You’ve purchased something for $1 that’s worth $1,” he said.

But if the government buys something from a financial institution for $1 that is by some fair value of accounting basis only worth 50 cents, the government has lost 50 cents, and that is added to the deficit in that year.

“At this time, given the lack of specificity regarding how the program would be implemented and even what classes [of assets] would be purchased by the secretary, CBO cannot provide a meaningful estimate of the ultimate net cost of the administration’s proposal,” said. But assuming that there is still value in the mortgage-based assets that the Treasury Department plans to buy, the net cost “should be substantially less than $700 billion,” Mr Orszag added.

It’s an issue that congressional critics – and the voters flooding congressional phone lines with protests – are likely to challenge. The devil isn’t just in the details of how the rescue plan is drafted, it’s also in the practice of dealing with highly complex new financial instruments, those critics say.

“We’re going down [an] uncharted path. We’ve never gone down a road like this with such intensity and such a massive amounts of money,” says Sen. Richard Shelby (R) of Alabama, the ranking member on the Banking, Housing & Urban Affairs Committee. “I think it’s a horrible mistake.”

“What [the Bush administration] is saying is there are going to be outlays when you acquire these assets, but eventually if you hold on to these and prices recover, you’ll be able to offload them maybe at a profit but certainly not [at] much of a loss,” says Steve Ellis, vice president of Taxpayers for Common Sense, a Washington-based group that advocates for lower deficits.

But the difference between this situation and the model from previous savings and loans bailouts from the 1980s and ’90s is that mortgage systems have become much more complex, he says. “What you have now is not just the mortgage-backed securities, but you also have these much more exotic instruments – that were hedges against losses and hedges against those hedges – [and] when you unspool some of these, there isn’t going to be anything.”