Cost of GFC2 bailouts: $6.7+ trillion?

Posted: August 14, 2011 in Austerity, Credit rating agencies, Euro, Europe, European Central Bank, Financial crisis, Global financial crisis 2.0, Risk, sovereign debt

As the global economy inches closer to Global Financial Crisis 2.0 or GFC2, the Leadership of the Group of 20 Nations is attempting to head it off at the pass by assembling a Frankenstein coalition of nations willing to underwrite a huge new bailout of ailing banks. Although estimates vary as to the total amount that might be needed, figures from $2.5 to $6.7 trillion dollars have been floated (hat tip to @paulstpancras):

These forecasts — excepting the Times article — are all old: the NPR article is a month old and the other two are from the Spring. So, conceivably, the total could be higher today. And, considering how the leadership of the world usually waffles over exactly how to handle these situations until a bad situation gets worse, the total price tag will continue to increase while some kind of solution is found.
I don’t know about you but I can’t even wrap my head around these numbers. As if the first round of bailouts during the first global financial crisis wasn’t bad enough — these numbers are higher, and even more offensive. Really, we know better. But so little has been done to change the regulatory, economic, political and financial environment that this outcome is virtually inevitable.
Worst yet, another bailout won’t change anything. Well, it might change something: banks and the financial elite who run them will be further emboldened by the wholesale enabling of the politicians and taken even more risks with someone else’s money. And the people who are already struggling to make ends meet will find themselves facing benefit cuts, higher unemployment in recession-oriented economies. That’s because politicians will justify even more austerity in the name of deficit reduction following this next round of bailouts.
But even if the G-20 can conjure up this mind-blogging sum, it still might not be enough. That’s because the system is so volatile, so full of risk, that something unexpected could come out of left field and bust the system wide open before this new bailout is put together.
Obviously, the banks are the biggest risk out there right now. Markets are pricing bank stocks in an eerily similar fashion to pre-bailout 2008; 186 US financial institutions are trading at 60 percent of book value, including Bank of America, Citigroup and Morgan Stanley, according to Bloomberg.
Then, the problem was toxic mortgage assets. Now, the problem is toxic sovereign debt AND an overhang of toxic mortgage debt. Not only have banks not cleared all the bad mortgages from the housing boom, but they are being sued right, left and center over bad securitization and underwriting practices from that era. Not surprising.
Credit rating agencies are one wildcard; we’ve seen the turmoil that one rating agency downgrade of the US can foster. In this unstable economic environment, an ill-timed sovereign debt downgrade could start a cascade of bank downgrades or write-downs, sending the global economy into a Lehman Brothers style crisis.
Actually, the rumors surrounding French Bank Societe Generale are already raising fears that a French sovereign debt downgrade would negatively impact the bank’s capital, according to the New York Times. Conversely, a bailout of this or any other French bank would also potentially imperil the country’s AAA credit rating.
And if France losses it’s top-notch credit rating, say goodbye to the AAA credit rating of the European Central Bank (ECB), one of the main entities behind the attempt to save the Euro.
And what about the banks here in the USA? Rumors have been swirling for weeks that Bank of America is in a perilous financial situation, and may need some kind of bailout. BOA or any other large bank failure could start a destabilizing chain reaction impacting other banks and freezing up the bank system internationally.
And that’s not even including the whole issue of credit default swaps, a type of insurance that banks and companies can take out to hedge against default. No one even knows the CDS exposure on sovereign debt or what might happen if a big sovereign, such as Italy or Spain, needed a massive bailout or a systemically important bank did.
Ugh. I’m getting a headache. The longer the situation goes on, the more potential there is for destabilizing events that could blow up the entire system. Sounds like the choices are:
  1. A horrifically expensive bailout that will kick the can down the road a few more years
  2. A financial crisis that will cripple the global economy and all but destroy the TBTF banks
  3. The unknown
None of these alternatives is particularly appetizing. But I’m betting it won’t be too long before one of them is a reality.
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Comments
  1. […] how much will another bank bailout cost the world? How about $6.7 trillion? Share this:FacebookDiggRedditEmailStumbleUponPrintTwitterLike this:LikeBe the first to like this […]

  2. Frances Coppola says:

    Here’s a nasty thought. Total global GDP is of the order of $40tn. The total amount of potential liabilities thought to exist in the global financial system is in excess of $100tn. Bailout might bankrupt the odd country or two, but catastrophic failure of the global financial system could bankrupt the entire world. We have created a monster which threatens to destroy us if we don’t keep feeding it. No solution that uses existing monetary and fiscal practices will do more than satisfy its appetite for a short while – then it will come back, bigger and hungrier than ever. We need a new global financial system that reinstates the responsibility of governments to care for their people and puts the welfare of people before the stability of institutions.

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