What Caused The Bailout Loss Estimate's $200 Billion Revision?

The news is abuzz this morning that the Obama administration has revised its estimate of taxpayers' loss on the bank bailout by a whopping $200 billion. While this certainly appears good, most articles I've read are missing the real story here. In fact, the administration's original estimate was so ridiculously pessimistic that it's utterly unsurprising that a large revision was in store. Both its prior and recent estimates could be politically motivated than grounded in economics.

Let's look at the numbers. In August the Treasury estimated that it would lose $341 billion out of the $700 billion of funds it had to spend on the bailouts. Now it says it will only lose $141 billion. And of that, only about $42 will be losses to ailing companies who got money so far. The other approximately $100 billion in potential losses will be largely from banks requesting more money in the months to come and the Obama administration mortgage modification program.

About this revision, the Wall Street Journal reports:

The reduction stems in large part from faster-than-expected repayments by some of the nation's largest banks, as well as less spending on programs to help shore up the financial sector.

But speed should have nothing to do with it -- the time horizon for the losses is for 10 years. So really, this revision reflects a gross overestimate of how much banks would lose.

How bad was its estimate? Let's take the $100 million for homeowners and future bailouts out of the equation. That means the loss estimate changed from around $241 billion to $42 billion. So the administration got it wrong by roughly 83%.

Yet, the world hasn't fundamentally changed since August. In fact, I'd argue it's changed very, very little. Banks are a little healthier, but even back in August they were clearly on the mend. And even if you think the world has changed more than I do, I highly doubt anyone thinks it's changed by, well, 83%. Banks' equity certain isn't worth 83% more: JP Morgan is down 2.8%; Goldman Sachs is up 2.2%; Bank of America is down 0.9%; and Citi is up 5.2%. The S&P 500 is only up by 8.7% over that time period.

I suspect this new estimate is more politically significant than economically meaningful. Back in August, the administration probably had a purposely pessimistic estimate so that it would look better when it was eventually revised it in a positive direction. While the original estimate would likely be blamed on the Bush administration, the new estimate could be spun to reflect the progress made during the Obama administration.

Now, I worry the political winds might be blowing their loss projection in the opposite direction: this new estimate might be a little too optimistic. With all of the focus on the deficit, this new projection helps. It lowers the deficit estimate from $1.5 trillion to $1.3 trillion. This makes it politically easier for Washington to get a jobs-focused stimulus passed.

Maybe I'm a too cynical about Washington estimates, but I just can't believe that a loss estimate should change by 83% in just four months without some earth-shaking change in the economy.