Sunday, October 19, 2008

Bailout to Swell Debt and Hit Taxpayers While Housing Values Sink

Bailout to swell debt, hit taxpayers

Analysts say hikes almost inevitable

By Robert Gavin, Boston Globe Staff
October 19, 2008

The shape and scope of the Wall Street bailout is finally clear, but a big question remains: How will we pay for it? Propping up the US financial system will require the federal government to borrow hundreds of billions of dollars, adding to a ballooning deficit that will hamstring the next president and eventually require Americans to pay higher taxes, analysts said.

The deficit was already set to soar as tax collections plunge in the face of a likely recession. But the cost of bailing out financial firms, plus an economic stimulus package promised by congressional leaders, could send the national debt to levels not seen since the Reagan administration, analysts said. Economists forecast the deficit will top $700 billion in the current fiscal year, which began Oct. 1, up from about $450 billion the previous year.

It's not going to get better in the next fiscal year, either. Over the next two years alone, the government will probably have to borrow some $1.5 trillion to keep operating, adding to a national debt that now tops $10 trillion, analysts said. Meanwhile, the government - and taxpayers - face huge increases in the costs of Social Security and Medicare, the healthcare program for the elderly, as some 78 million baby boomers begin retiring over the next few years.

"When you start looking at the trajectory of the deficit and the debt, whoever is elected the next president will be handcuffed," said Rudolph Penner, senior fellow at the Urban Institute, a Washington, D.C., think tank. "Taxes almost certainly have to go up at some point."

It's generally viewed as appropriate to increase government spending and deficits to help the nation avoid, moderate, or rebound from recessions, but running such big deficits over the long term poses several risks to the economy, analysts said.

First, the massive borrowing needed to finance big deficits year after year can siphon away capital that companies need to grow, as investors buy government, rather than privately-issued, securities. When the government borrows, it sells securities that compete with private offerings for investor dollars. In addition, as debt markets become flooded with US securities such as Treasury bills, the government may need to pay higher interest rates to attract enough buyers.

That would mean higher rates for mortgages and other loans, which are frequently tied to Treasury bill rates, and ultimately, slower economic growth. Finally, it would make the nation and the economy more dependent on foreign governments and investors, who already finance a large share of US debt.

"It's important to get the economy off its back, but once we get through this, we have to deal with these big deficits," said Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pa. "You can cut spending or raise taxes, and we'll probably have to do both."

Surging deficits make it less likely that either presidential candidate would be able to enact tax cuts, at least not on the scale they have promised, analysts said. Former President Bill Clinton, they noted, had to give up his promised middle-class tax cut after taking office in 1993 in the face of a weak economy and high budget deficits.

Senator Barack Obama of Illinois, the Democratic nominee, has promised a middle-class tax cut, while Senator John McCain of Arizona, the Republican nominee, has promised broader tax cuts for individuals and businesses. Either plan would increase deficits by trillions of dollars over the next 10 years, according to an analysis by the Tax Policy Center, a joint program of the Urban Institute and Brookings Institution, another Washington think tank.

Obama has said the nation will be able to afford his proposed tax cuts, as well as initiatives to make healthcare more affordable and develop alternative energy, by raising taxes on the wealthy and cutting spending in other areas, such as the war in Iraq.

"We are paying the price for ignoring healthcare and energy for the past seven years," said Brian Dreese, Obama's deputy economic policy director. "Barack Obama believes we cannot afford to wait on providing tax relief to middle-income families, investing in alternative energy, and lowering healthcare costs."

McCain has said he would pay for his tax cuts by reducing spending, but he has provided few specifics. His campaign did not respond to e-mail and phone requests for comment.

It's still unclear how much the financial bailout will cost in the long run, but most analysts expect it to end up substantially less than the initial outlay of up to $700 billion. Once the financial system regains its health, the government can sell the assets it will purchase under the bailout, including bank shares and mortgage-backed securities held by financial firms, to recoup costs. Other countries, such as Sweden, have undertaken similar bailouts of banking systems, and recovered about two-thirds of the initial costs, analysts said.

In the short term, however, the bailout will boost the deficit significantly. Global Insight, a Waltham forecasting firm, estimated the bailout plan will account for slightly more than half of the $300 billion projected increase in the deficit this year.

The deficits forecast for the next two years, equivalent to about 5 percent of the nation's economic output, or gross domestic product, would approach those of the Reagan administration, when deficits peaked at about 6 percent of output. To eliminate the crippling deficits, President Ronald Reagan's successors, George H.W. Bush and Clinton, each agreed to tax increases and spending cuts.

Tax increases, which can slow economic growth, probably wouldn't come until the economy recovers, which could take a few years. But they are coming, many analysts predict.

"We have a deficit that is big, and was already getting bigger, even before this bailout," said Nariman Behravesh, chief economist at Global Insight. "One way or another, taxes have got to go up."

Robert Gavin can be reached at rgavin@globe.com.


US house prices face long fall to bottom: analysts

by Adam Plowright
Sun Oct 19, 1:05 pm ET

WASHINGTON (AFP) – The falling US housing market, the trigger for the global financial crisis, is still far from reaching the bottom, promising more pain for consumers and more bad debt for banks, analysts say.

With the real estate bubble burst, prices are sinking under pressure from a glut of unsold homes, particularly in areas like California, Florida and Arizona, rising unemployment and foreclosures, as well as tightening credit conditions.

"In terms of prices, I don't think they'll bottom out until the end of next year and I don't think they're going to bounce back. They'll crawl back," chief economist for ratings agency Standard & Poor's, David Wyss, told AFP.

He sees another 10 percent fall over the next year measured by the Standard & Poor's/Case-Shiller property survey that tracks prices in 20 cities. The market has fallen by 20 percent since its peak of July 2006.

The adjustment will not be reversed by proposed government intervention to help homeowners threatened by foreclosure, analysts say. As economic conditions worsen, the property market looks a one-way bet in the short-term.

"We're in an ugly little spiral at the moment," said Keith Gumbinger, vice president of HSH Associates, a research company that tracks the mortgage market by surveying 2,000 lenders weekly in the United States.

"The market is suffering from oversupply and there has been very little improvement in factors that would contribute to demand," he told AFP.

"We could be talking another year before we see a stabilization and that all hinges on whether the economy deteriorates to a great degree."

In the booming decade preceding 2006, home building rocketed as developers cashed in on easy credit and strong economic conditions. Demand was stimulated by mortgage companies giving easy loans with few conditions.

Now, thousands of new homes stand empty, joblessness is rising, mortgage rates are higher and people are defaulting on their payments, triggering firesales of foreclosed homes at knock-down prices.

After a month of financial chaos when the global monetary system was on the brink of meltdown, the broader economy now looks more vulnerable than ever, raising the prospects of a deep recession that would further reduce incomes and housing demand.

"The house price figures that we have are prior to the events last month on the stock market," said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania.

"We don't know yet the impact of the economic turmoil on the housing market and I suspect it will not be positive."

Despite a US government rescue of mortgage giants Freddie Mac and Fannie Mae and a 700-billion-dollar program to rescue banks, mortgage rates are still rising and will remain high relative to the levels of previous years, analysts say.

Bankrate.com, which tracks the home loan market, says the rate of an average 30-year mortgage rose by 0.5 percentage points to 6.74 percent last week, its biggest one-week jump since 1987.

Gumbinger, who estimated the rate at 6.75 percent, said this compared with a low of 5.61 percent in January and should be viewed in a context of tightened conditions where lenders are turning away people with poor credit ratings or small down-payments.

"There are borrowers who grew up in a time when credit was available in any circumstances and that is no longer the case," he said.

One mitigating factor for prices is that property companies are reacting fast to reduce the supply of homes. This will eventually support prices when it filters through, but is unfortunately bad news for the broader economy in the short-run.

Construction starts on new US homes slumped an additional 6.3 percent in September to the lowest level since the recession in 1991, official data showed Friday.

Year-over-year, housing starts were 31 percent below the level of construction in September 2007.

"Although the builders have cut back pretty sharply on new homes, most of the problem is existing home inventory," stressed Wyss. "The problem is that the market is going to have to overcorrect to get rid of the oversupply that's out there."

Existing home inventories are high because of the glut of newly finished unsold homes sitting on the market, the difficulty of selling older homes in a market with few buyers and an increase in foreclosed property.

Jed Smith, a researcher from industry group the National Association of Realtors, also saw a glimmer of hope in 2009, forecasting a modest 2.0-percent increase in prices nationally over next year.

"The increase is likely to come towards the latter part of 2009," he told AFP.

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