It’s a slow day in a little East Texas town..
The sun is beating down, and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit.. On this particular day a rich tourist from back east is driving through town.

He stops at the motel and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night..

As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill at the supplier of feed and fuel.

The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her “services” on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and now looks to the future with a lot more optimism.

And that, ladies and gentlemen, is how the United States Government is conducting business today.
Author unknown

Published: February 13, 2010

AS Washington spins its wheels on financial reform, it’s becoming painfully clear that the problem of entities that are too interconnected or “too politically powerful to fail” is also too hard for our policy makers to tackle.

This is more than unfortunate, given how large the too-influential-to-fail gang has grown in recent years. Once a small membership organization comprising Fannie Mae and Freddie Mac, the mortgage finance giants, and the occasional troubled auto company, the Future Bailouts of America Club now includes a long list largely populated by financial institutions.

We can’t be sure who the specific members of this club are — regulators simply say they know ’em when they see ’em. But this much is certain: They’ve seen a lot of them lately.

As taxpayers, we obviously can’t rely on lawmakers to address the risks we face from the ever-expanding corporate safety net thrown under teetering behemoths. But because we are footing the bills for these rescues — and will do so again if more crises occur — don’t you agree that we should know what these implied federal guarantees will cost us?

If the government won’t reduce the size of the safety net, and it has shown no appetite for doing so, it should at least tell us the price tag.

Marvin Phaup, a research scholar at George Washington University who examines federal budgeting, is one who is urging such an assessment. An expert on government guarantees, his wholly sensible view is that it is dangerous for possible bailout costs to remain unmeasured and, of course, unrecognized in the budget. “If we are extending the safety net, extending the implied guarantee to the debts of a lot of other financial institutions, and we know those guarantees are valuable and costly, then we ought to start budgeting for it,” Mr. Phaup said in an interview. “We can’t reduce the costs of these subsidies if we can’t recognize them.”

Mr. Phaup has the bona fides to opine on this topic. He was the researcher at the Congressional Budget Office in 1996 who undertook the first efforts to assign a value to the implied federal guarantee backing Fannie and Freddie. When he prognosticated on the matter, the bailouts of those two hobbled entities were more than a decade away, but his C.B.O. report quantified the billions in benefits that the mortgage finance companies reaped each year from their implicit government backstop.

In 1995, the report said, the value of the companies’ government subsidy totaled $6.5 billion; this amount largely reflected lower borrowing costs at the companies, a result of views held by investors that Fannie’s and Freddie’s obligations had Uncle Sam’s backing.

THE C.B.O. report enraged Fannie and Freddie because it also showed how much of that financial benefit — fully one-third — the companies kept for themselves, their managers and their stockholders. Mr. Phaup’s analysis showed that, counter to the companies’ claims, Fannie and Freddie did not pass along all the benefits to homeowners in the form of lower mortgage rates.

Moreover, who actually believed in 1996 that the government would ever have to bail out Fannie and Freddie? Perish the thought and shame on silly researchers like Mr. Phaup for even considering such possibilities.

Fast-forward to today, and the government guarantees for Fannie and Freddie have become painfully explicit. While it’s unclear how much their rescues will cost taxpayers, last Christmas Eve the government removed the $400 billion cap on the amount of assistance it was willing to provide the companies in emergency aid through 2012.

Today’s implied guarantees extend well beyond Fannie and Freddie. But owning up to future obligations associated with government backing is something that lawmakers are likely to fight vigorously. (Consider Social Security.)

But ignoring such obligations doesn’t make them go away. And getting a handle on their possible cost is a worthy exercise, for several reasons.

First, Mr. Phaup said, if we assign a value to the guarantees, the government would be better able to charge for it. “Even if we don’t do that, by recognizing the cost now we will save more because we will either tax more or preferably spend less” to pay for it down the road if need be, Mr. Phaup said. “In the end, that’s really the only way to prepare for a contingency like a meltdown of the financial system.”

A second benefit is that recognizing the costs of guaranteeing too-influential-to-fail institutions might reduce the ultimate obligation and persuade regulators and lawmakers to force those institutions to cut back on risk-taking.

It’s not as if the costs associated with these guarantees can’t be accurately estimated. Valuing so-called contingent claims, chits that have not been called in, has become a much more sophisticated process in recent decades, Mr. Phaup pointed out. “We know how to do it for private firms,” he said. “Fewer people in the government know how to do it, but those skills can be transferred.”

Edward J. Kane, a professor of finance at Boston College, agrees that the costs associated with providing a safety net for complex and politically connected companies should be quantified. “People talk about systemic risk, but they have no metric of measuring it,” he said. “If we recognize that obligations are being put on the taxpayer down the line, then they can be controlled and managed.”

Mr. Kane suggested that lawmakers create an independent entity to collect data from all the protected firms so a realistic price tag could be placed on possible bailout costs. “We would force the institutions to give preliminary estimates and then challenge them,” he said. The combined figure for all the institutions would represent the total responsibility being shifted onto the backs and wallets of taxpayers.

“If government officials really wanted to do something, this is the kind of thing they would do,” Mr. Kane said.

That is the rub, of course.

Lawmakers interested in re-election have little incentive to be truthful about what implied guarantees of powerful companies will cost the taxpayer. Better to brush it under the rug or pretend the costs don’t exist. Then, when they must be paid, policy makers can argue that it’s an unforeseen emergency and an odious necessity.

As the number of firms with implicit government backing has risen because of the crisis, so too have the expected costs of those commitments, Mr. Phaup said. And yet, under current budget policy, those costs will be ignored until the recipient of the guarantee collapses — the precise moment when the guarantee is likely to cost taxpayers the most.

Three years into the crisis, we are no closer to reining in too-powerful-to-fail companies or eliminating the risks they pose to taxpayers. Both goals are achievable, yet our legislators refuse to do what is necessary to protect us from trillion-dollar bailouts down the road.

It’s a disservice to a bewildered and beleaguered nation.