Aaron's Real Opinions:

The Real Cost of the Bailout
Isn't 100% annual interest usurious? by Aaron Harber
September 28, 2008- Print Article

Part 1: How The $700 Billion Bailout Could Cost $700 Billion Every Year

In their rush to show voters they are proactively doing something to solve the financial crisis crushing Wall Street, the House, the Senate, and the Bush Administration have put together a bailout which not only actually may worsen the situation but whose true costs could stagger the American Economy. And these costs could rise to an annual total equal to the bailout itself. Hence, Americans would be paying an effective interest rate of 100% on the original cost of the bailout?

Not only are the politicians overspending and wasting taxpayer dollars, they are creating conditions which are highly likely to severely worsen every American's financial position. And, on top of this, they not only are intentionally are hiding the potential costs which could destroy the U.S. Economy --- all for the sake of a photo opportunity prior to the General Election --- but are giving taxpayer dollars to entities who are likely to invest them outside of the U.S.

Specifically, the $700 billion bailout is likely to initially hit taxpayers with $200 to $400 billion in losses after the Federal Government tries to sell the bad assets it purchased at prices far above the market value of what they will pay.

Part 2: Is Wall Street Really Looking Out For America's Best Interests?

The claims by Wall Street leaders and politicians that taxpayers will make money on the toxic assets being purchased are disingenuous. If purchasing these assets were such a great bargain today, investors would be snapping them up instead of heading for the hills. So, unless you believe Washington politicians are financially more astute than the traders on Wall Street, it's easy to see who is getting conned and who is doing the conning.

Mistake #1 is not buying assets at market value and, instead, paying an artificially high value to those who need the money the least. These sharp investors will put the funds where they can find the greatest return --- and that likely will be investments overseas, not in the United States.

Mistake #2 is borrowing the $700 million plus the prior funds already used for a bailout total of more than $1 trillion (this is a more accurate estimate of the initial cost of the bailout). This means adding $1 trillion to our already high $10 trillion National Debt --- a debt level almost everyone agrees already is excessive. There are a number of costs associated with these actions which are not being discussed.

Part 3: Increasing Our Debt By $1 Trillion Will Increase Interest Rates

First, the additional borrowing will increase interest rates across the board, especially given the relative lack of desire on the part of investors when it comes to U.S. Government borrowing. Some of our largest creditors are looking for ways to get rid of dollars --- not accumulate more. If this impact on interest rates ultimately is as high as just two percentage points, the costs are enormous. And it could be far more than just two points given the fact interest rates are at superficially low today.

Second, we will have to pay interest on the $1 trillion bailout. At 5% annually, that is an extra $50 billion in taxpayer dollars which does nothing constructive. All it does is drain the U.S. Treasury --- with many of those dollars going out of the country. At 10% annually, the amount rises to $100 billion --- just to carry the debt and not even pay it back. That's $100 billion wasted every year possibly for decades.

Third, and more importantly, the additional borrowing likely will increase the average rate of interest paid on the entire national debt as well as on U.S. consumer and corporate debt. Shifting the focus from the new $1 trillion in debt to the entire $11 trillion National Debt potentially increases that segment of the cost tenfold.

Part 4: Small Interest Rate Increases Mean Big Dollars

Again, even if this increase is only two points (2%) --- which may be an overly conservative assumption --- it means adding $100 billion a year in interest payments for the $10 trillion National Debt (this nets out additional interest Americans would receive from higher interest rates because foreigners own about half the National Debt). U.S. consumer debt totals over $2½ trillion so just a two-point rise could mean an extra $50 billion Americans would have to pay directly out of their pockets each year --- and get nothing in return. And given the lack of restrictions on consumer interest rate increases, this number could easily reach $100 billion annually.

If home mortgage rates increase by an average of just two points, that could add even more to the total. American home mortgage debt totals $11 trillion but much of that is not subject to changing rates which do affect new mortgages and adjustable rate mortgages. The likely impact of a two-point interest rate increase could be on the order of $100 billion annually and could increase over time to $200 billion annually as new mortgages replace old ones.

An interest rate increase also would impact commercial and other business-related debt which currently totals approximately $29 trillion. Much of this debt is very sensitive to short-term interest rate changes so a two-point change easily could result in a $350 billion increase in business and financial sector interest obligations. This increase also would have to be passed on to consumers and other business customers.

Part 5: Don't Forget The Penalty Americans Will Pay For A Depressed Dollar

Even worse, spending $1 trillion we do not have also will put further downward pressure on the dollar. If that pressure results in just a 5% decline in the value of the dollar, Americans' standard of living will fall as goods made outside the country become more expensive.

Such a change would mean U.S. consumers could pay an extra $100 billion annually on the $2 trillion they purchase from other countries --- with no net gain in actual goods and services purchased. Hence, we would pay an extra $100 billion for the same products we are purchasing today. Given potential fluctuations in currency rates, this number could easily double or triple in a period of time measured in months, not years.

Part 6: Washington's Cure Could Kill The Patient

So, before the bailout is done, the politicians should realize their efforts to save the American Economy may only serve to make it far worse. While we may "feel good" when we experience the rush of $700 billion being injected into the Economy (and even then, we're putting those funds into the wrong hands --- they should go to consumers who will spend the money right here in America and help pump prime the Economy rather than to sophisticated investors who will send the money out of the country), in just a matter of months --- not years --- we may find the decision was a terrible mistake.

As the preceding analysis demonstrates, it is possible the bailout ultimately will cost Americans the equivalent of an interest rate of 100% --- i.e., annually adding the same amount ($700 billion or more) every year to our total financial obligations. At that point, the bailout --- instead of saving us --- could put us in a financial death spiral.

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