Potential Cost of Bad Mortgages

The question on many minds is what if the $700 billion Treasury Secretary Paulson is asking for isn't enough to restore market order? What's the potential (if unlikely) amount that the government would have to shell out to get low-quality mortgage-linked derivatives off of bank balance sheets?

A new report from the Congressional Research Service provides an answer:

According to one industry source, the estimate of outstanding non-agency MBS was $1.3 trillion at the end of 2007, with another $25 billion issued in 2008. There was also another $1.3 trillion in outstanding collateralized mortgage obligations. Thus, the total amount of mortgage-related assets that might be acquired by the program would be nearly four times the $700 billion limit in the proposal. The above estimate does not include any direct purchases of whole mortgage loans or derivatives that reference the mortgage-related assets. However, it might be double counting to include both the mortgage-related securities and the underlying mortgages or referenced derivatives. If issues with the underlying mortgages are resolved, then any mortgage-backed security or derivative that references those mortgages would not be in default

In a separate report, the CRS lists the returns achieved on government bailouts of years past:

Beneficiary	Action	Financial Commitment	Final Cost to Treasury
U.S. Airlines (2001)	Loan Guarantees	Up to $10 billion	None except implicit value of loan guarantees; under $2 billion in loans made.
Savings and Loan Failures (1989)	Savings and Loan Failures and Insolvency of Federal Savings and Loan Insurance Corporation	Full faith and credit backing of Federal Savings and Loan Insurance Corporation	$150 billion.
Chrysler Loan Guarantee (1980)	Loan Guarantees	$1.5 billion	$311 million profit from sale of warrants.
New York City (1978)	Loan Guarantees	$1.65 billion in guaranteed bonds	None, except the implicit value of loan guarantee.
New York City (1975)	Short-Term Loans	$2.3 billion	None, except the implicit cost of the risk of loan.
Penn Central (1974)	Loan Guarantees in the wake of Railroad Bankruptcy	$125 million loan guarantees; $7 billion in federal operating subsidies	$3 billion net loss after sale of ownership stake and the implicit value of loan guarantee.
Lockheed (1971)	Loan Guarantees	$250 million of loans guaranteed for five years with three year renewal; guarantee and commitment fees charged	$31 million profit from sale of warrants less the lost value of loan guarantee.

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