Friday, September 26, 2008

Estimated Cost of Bailout: $700 Billion; Return of Investment: TBD

In Enterprise IT world no IT project gets funded without a formal Return of Investment analysis. Even in very beginning phases of project, often called initiation/qualified idea phase, a very high-level business case including ROI & risk assessment is predicament to fund the resources required for further definition. It is not uncommon for large Enterprise Initiatives to get approval for the overall budget soon after the ROI justification, however funding of budget will be done in a phased approach, only upon the successful conclusion and review of deliverables from earlier phases. In contrast, operational costs are recurring cost of business operations and do not necessarily require extensive ROI analysis for funding.
On corollary, most fiscal government policies are enacted into law and generally do not require additional approvals. Chairman Bernanke sometime back clarified that the proposed bailout plan is not a fiscal plan instead it’s a market-focused initiative that buys (and sells) assets using market-focused pricing strategies such as options. While everyone agrees that something need to be done to help the economy, market-focused initiative of this size demand clear quantification of associated costs, risks and value. However, these are the missing pieces in this puzzle currently.

H.J. Huneycutt wrote “It's a mystery to me as to why the concept of ROI is constantly evoked in the business world, yet almost never used when evaluating government policies. If the government can complete a task more efficiently than the private sector, then by all means it should do so. If it cannot, it should keep away.”

While no detailed ROI assessment in testimony, below are some interesting estimates from bloggers on cost of doing/not doing this.

Calculated Risk:Price is still the key. Since Treasury doesn't plan on churning the $700 billion, the losses will be a portion of the amount invested - and the losses depend on how much Treasury pays (or overpays!) for the assets. The losses are unknowable at this point, but probably in the zero to $300 billion range

Brett Arneds in his WSJ Blog:The Federal government pays just 4.34% interest on long-term, 30-year loans. So the government could borrow this money for 30 years at a cost of just $30 billion in interest per year. Let's take a worst case scenario. Let's imagine Uncle Sam borrows $700 billion to buy these assets and never gets a single penny of it back. Let's imagine this paper ends up completely worthless. So instead he has to tap taxpayers to pay off part of the principal every year for 30 years, until the loan is all redeemed. How much would that cost per year? Try $42 billion. That's the interest and principal repayment.
That's less than one-third of 1% of our annual gross domestic product. That's the true, annual cost of this bailout.”

On cost of doing nothing (Benefits):

Washington Post: "If nothing is done, the potential for these markets to seize up in a big way is definitely there," said Frederic S. Mishkin, an economist at Columbia University who was a Federal Reserve governor until last month. "When you look at the history of these crises, when things spin out of control, the cost to fix it later goes up exponentially."

CNN Money: "Economists say that without a restoration of credit, unemployment would likely shoot up to over 10% from 6.1% today. And GDP could fall at an annual rate of between 2% and 4%"

The recent debacle of AIG, Lehman and other financial institutions providing profound evidence for the urgent need for detailed planning & risk management, it is imperative to have a detailed plan of action in place before expending valuable tax payer money.


Sean O'Cairde said...

Its not the bail out thats in question but the over sight. In Business we always have a due diligence before any involvement or risk. In this situation, the goverment is panicking, not doing due diligence, nor providing adequate oversight.
If we step back, I believe the banks themselves will come to the rescue as they still have more to lose. If they see goverment bail out, they will be reluctant to bail themselves out.

Gopi Padakandla said...

Thanks for comment John. I totally agree with you that due diligence in planning, oversight and systematic risk management are imperative for the rescue plan to enable intended economic benefits.