Nov. 6, 2009 — -- Federal government guarantees to back up bank assets during the financial crisis posed a "considerable risk to taxpayers" last year, but the guarantees ultimately played "a significant role" in calming the markets, and now taxpayers appear set to earn a profit, a government watchdog panel said Friday.
In a new report released Friday, the Congressional Oversight Panel said that at its peak the federal government – through the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corporation – was guaranteeing $4.3 trillion in face value of bank assets, making it the single largest part of the government's response to the crisis.
While the total taxpayer exposure was never $4.3 trillion, the panel warned that these guarantees posed "considerable risk to taxpayers.
"If the guaranteed assets had radically declined in value," the watchdog cautioned, "taxpayers could have suffered enormous losses."
But now, said the panel, it appears likely that the government will rake in more revenue in fees from the guarantees than will ultimately be paid out.
Ultimately, the panel said, taxpayers "appear likely to earn a profit from fees assuming economic conditions do not deteriorate further."
When Congress authorized the $700 billion financial bailout plan last fall, it also gave government agencies the power to support the value of assets indirectly by issuing guarantees.
A guarantee is essentially a promise by one party to back another party's obligation to a third party. It is similar to what the FDIC does by backing up bank deposits up to $250,000. If a bank fails and depositors cannot obtain their money, the FDIC, having guaranteed that debt, will step in and provide the funds.
In addition, said the Congressional Oversight Panel, "The enormous scale of these guarantees played a significant role in calming the financial markets last year."
While praising the successes of the guarantees, the panel, chaired by Elizabeth Warren, still warned about the dangers of such a program.
"Extraordinary transparency", they said, is necessary, as is the disclosure of "greater detail about the rationale behind guarantee programs, the alternatives that may have been available and why they were not chose, and whether these programs have achieved their objectives."
The massive government backing, the panel noted, also increased the threat of "moral hazard" -- the possibility that the government would behave differently if its level of risk were different. The panel cautioned that "to the degree that lenders and borrowers believe that such an implicit guarantee remains in effect, moral hazard will continue to distort the market in the future."