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Summary:

Governments in advanced economies absorb a large and growing share of aggregate credit risk. That exposure arises from explicit and implicit contingent liabilities such as the ones that culminated in bailouts during the Global Financial Crisis (GFC) and from loan guarantees extended during the Covid-19 pandemic. Despite the growth of credit policy as a crisis response tool and substitute for traditional fiscal assistance, governments continue to underreport the associated costs and risks. More comprehensive and timely cost estimates, produced using a fair value framework, would increase transparency and discourage overreliance on these policies. Such cost estimates for the GFC bailouts and Covid-19 pandemic guarantee programs reveal costs that were an order of magnitude lower than the risk exposures those policies entailed but nevertheless were large enough to call into question whether less expensive and less risky policy alternatives could have achieved the same goals.

Key findings:

1. The major GFC bailouts—the rescues of Fannie Mae, Freddie Mac, Citigroup, AIG, and other large institutions; expanded FHA mortgage insurance; the Federal Reserve's emergency liquidity facilities; and expanded FDIC insurance—exposed taxpayers to trillions of dollars of potential losses and had a fair value cost of about $500 billion.
2. The Covid-19 pandemic loan guarantee programs exposed governments in advanced economies to more than $4 trillion of potential losses and to costs totaling $330 billion.
3. The direct beneficiaries of these policies vary significantly over time. At the onset of a crisis, existing debt holders and uninsured depositors reap the gains. During normal times, bank equity holders, customers and borrowers benefit from lower funding costs.

Center Affiliation: Center for Financial Innovation and Stability

JEL classification: E44, F33, G15

Key words: international lender of last resort, Federal Reserve, financial crises, eurodollar

https://doi.org/10.29338/ph2024-03