The Cost of Doing Nothing

After overhearing two friends talking about how the money budgeted for the bailout could be used for better things I wanted to post two excerpts from an Economist article on the British banking bailout. Leaving aside the exact details of the US plan the important point to underscore is that there are two sides to the issue of budgeting - government spending and government revenue. While the bailout is clearly a drain on the budget, so is a slowing economy, and a dramatically slowing economy would be an economic nightmare. So spending money to help avoid economic disaster is a good idea, and an approaching recession is the wrong time to bring on budgetary austerity. Next up - getting the details of the bailout as right as possible.

Government Spending:

Such a ballooning in the government’s liabilities may seem ominous, but this is to look at only one side of the public balance-sheet now that the Treasury has turned banker: on the other side stand the assets. [...] In 40 banking rescues studied by Luc Laeven, an economist at the IMF, the taxpayer typically recouped some but not all of their cost.

Set against this, the stakes are intended to be temporary, and the public purse could profit when the shares are eventually sold. Taxpayers could also make running gains from the overall package, says Ben Broadbent, an economist at Goldman Sachs, a bank. Although the Treasury will have to pay interest on the new gilts it issues to fund the recapitalisation, it will recoup over half of this from the 12% interest its preference shares in the banks will earn. It will also charge fees for the guarantees it is providing on £250 billion of new debt issued by British banks—another part of the rescue package. Putting it all together, Mr Broadbent estimates that the net gain to the exchequer—assuming it does not have to pay out on the guarantees—could be nearly £3 billion a year.

Government Revenue:

Recessions wreak havoc on the public finances by both cutting tax revenues and raising unemployment-related spending. For every percentage point that GDP is lower than expected, public borrowing will be roughly £7.5 billion higher than forecast in the first year, rising to £10 billion higher in the second year, according to the Treasury’s ready reckoner. If the economy were simply to stall in 2008-09 and 2009-10, this could double planned borrowing of £38 billion next year; if output were to contract over the period the outcome would be costlier yet.