Ignoring Reality Has a Price
Thirty billion dollars to keep Bear Stearns from collapsing. Another $85 billion for A.I.G. Hundreds of billions, here and there, lent to banks.
All told, the Federal Reserve has pumped $800 billion into the financial system, Ben Bernanke, its chairman, estimated on Tuesday. That figure doesn't include the untold sum that the Fed now plans to spend buying short-term debt so that companies can continue to pay for their daily operations. And it doesn't include any of the money the Treasury Department is laying out, like the $700 billion bailout fund or the $200 billion that could be spent propping up Fannie Mae and Freddie Mac.
After 14 months of crisis, the federal government — meaning you and me — has put serious money on the line. As a point of comparison, the entire annual federal budget is about $3 trillion.
Just how are we going to pay for all this?
The short answer is that the budget problems the country seemed to have a year ago are now even worse. Next year's deficit (relative to the economy's size) will probably be the biggest since 1992, and maybe since 1983. Taxes will have to rise or government spending will have to fall, if not both. Trying to contain the mess created by a bubble no doubt costs serious money.
Yet this is also a case in which the short answer isn't the full answer, or even the best answer.
As expensive as the damage control may be, it isn't likely to cost near as much as the headline numbers suggest. More to the point, the alternative — not spending some serious money to deal with the crisis — would probably end up costing a lot more. As it is, the various bailouts are not the main reason next year's deficit is growing. The deteriorating state of the economy is.
So if you want to conjure up some doomsday stories about the federal budget, I'm happy to play along (and will do so momentarily). But those stories aren't mainly about the credit crisis. They're about the dangers of ignoring economic realities — which, when you think about it, is how we ended up in this credit crisis in the first place.
The most newsworthy part of Mr. Bernanke's lunchtime speech on Tuesday was his sober overview of the economy. He called the financial crisis "a problem of historic dimensions" and indicated that the Fed would soon cut its benchmark interest rate once again.
But the bulk of the speech was a catalog of the extraordinary steps that the Fed and Treasury had taken since August and the delicate line they had tried to walk along the way. They have lent enormous amounts of money to banks and trumpeted those efforts to try to restore some confidence to the credit markets. Fed officials have pointed out that they are nowhere close to being out of bullets either. They work for the central bank, after all. They can always print money.
But Mr. Bernanke and the Treasury secretary, Henry Paulson, have also emphasized that they're not being too generous. They are mainly making loans and investments, and they expect to recoup much of the money they're spreading around.
Outside the government, economists differ about whether Mr. Bernanke and Mr. Paulson have been too aggressive or not aggressive enough and whether they have been aggressive in the right ways. But there is not much concern that they are taking on additional debt — or even about the amount of it.
"The policy actions are not likely to have a large effect on the budget over the next five or 10 years," Douglas Elmendorf, who has become a go-to Democratic economist during the crisis, told me. John Makin, of the conservative American Enterprise Institute, added: "The last thing I'm worried about right now is additional government indebtedness. There really isn't an alternative."
Mr. Makin pointed out that during Japan's long malaise, the government passed a stimulus package almost every year that was equal to more than 2 percent of the country's gross domestic product (equivalent to about $400 billion in this country today). But interest rates in Japan remained low, a sign that economic weakness, not deficits, was still the problem.
That being said, today's ever-expanding bailouts do create some dangers. You've probably heard the term moral hazard, which is shorthand for the idea that government rescues may lead investors to take new, unwise risks — and ultimately require yet more rescues.
The Fed is also setting itself up for tough decisions about when to end its various emergency programs. If it waits too long, it could leave so much money sloshing around the economy that inflation will take off. Fed officials have suggested they understand that they made precisely this mistake after the 2001 recession, when they kept interest rates low and added to the mania in the housing market.
Finally, there is the net cost of the bailouts, which may well be bigger than Mr. Bernanke has acknowledged. Under the new program announced Tuesday, the Fed will own the commercial paper that serves as short-term loans for companies. If some of those companies go bankrupt, the Fed could suffer some losses.
The Treasury's $700 billion bailout fund, meanwhile, is based on the premise that investors are collectively undervaluing assets and that the government can pay above current market prices without losing much money. "One has to be at least a bit skeptical," the economist Greg Mankiw says, "about the idea that government policy makers gambling with other people's money are better at judging the value of complex financial instruments than are private investors gambling with their own."
After talking with budget analysts, I think it's reasonable to assume that the bailouts will end up costing several hundred billion dollars, spread over several years. Perhaps $100 billion of that cost may come next year. Add in another $100 billion or so for the weakening economy — specifically the fall in tax revenue, increases in spending on social programs and the possibility of another stimulus package.
Even before the crisis, the Bush administration was set to bequeath a $550 billion deficit to its successor. Now, a better estimate appears to be $750 billion — or 5 percent of gross domestic product. The only years since the 1960s that the deficit has been nearly so large were the early 1990s (almost 4.5 percent of G.D.P.) and the mid-1980s (with a peak of 6 percent in 1983).
Obviously, next year's deficit is a problem. And if you assume the credit crisis isn't about to lift — which seems smart at this point — the ultimate cost of the bailouts could conceivably go higher. Whatever the final figure, it should still be put in some context.
Despite everything, the biggest fiscal problem remains, far and away, health care. Based on the rate that medical spending has been rising, the Congressional Budget Office forecasts that Medicare and Medicaid will take up 10 percent of G.D.P. within two decades, up from about 4 percent now. In today's terms, that would be the equivalent of adding at least $900 billion to the deficit every single year, in perpetuity. It makes the cost of the bailouts look like a rounding error.
When it comes to health care, we have a situation that is blatantly unsustainable. With the right choices, we can prevent that. But so far, we instead seem to be hoping that the situation will magically resolve itself, which is a recipe for big problems and perhaps even a crisis.
Let's see. That doesn't sound familiar, does it?