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Net Net: Promoting innovation and managing change

At stake in a financial system meltdown: $26 trillion?

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September 15, 2008, the day the 150-year-old Lehman Brothers declared bankruptcy.
Keith Lew | Flickr Vision | Getty Images

As the U.S. finance system just keeps getting bigger, so does the amount to which taxpayers, in an extreme case, would be exposed should things go haywire again.

The total portion of financial system liabilities that "are subject to explicit or implicit protection from loss by the federal government" has grown to a record 60 percent, according to the latest calculations from the Richmond Federal Reserve's "Bailout Barometer."

Total price tag for those guaranteed liabilities: $25.9 trillion.

That's a post-crisis high for a system that regulators and legislators have sought desperately to downsize. To no avail, though: The 2009 estimate put the total liabilities, including guaranteed and nonguaranteed, at $42.33 trillion; the latest assessment, updated in March, is $43.15 trillion, a 2 percent gain. The total guaranteed level rose from $24.92 trillion, a 3.9 percent gain.

The liabilities come from banking and savings firms; credit unions, government-sponsored enterprises including Fannie Mae and Freddie Mac, private pension funds and other financial firms.

Lots of liabilities

Financial firm type Guaranteed liabilities ($billion) Total liabilities
Banking and savings13,17117,676
Credit unions872907
GSEs6,2346.234
Private pension funds2,8913,105
Money market mutual funds2,7182,718
Other financial firms112,514
Total25,88743,154

These figures may seem alarming—or not.

On one hand, the last financial crisis saw $4.76 trillion disbursed through various Treasury, FDIC and Fed programs to the entities jeopardized during the crisis of 2007-09, according to an analysis on Sourcewatch using government data. However, the government actually made money on a number of those endeavors, particularly the Troubled Asset Relief Program.

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The Richmond Fed also makes it a point of emphasis that taxpayers likely never would be "on the hook" for such an extreme amount, as creditors would not lose that much and such a catastrophic event would be extremely unlikely to occur.

However, the numbers, and their direction higher, are worth contemplating in light of all the trouble the crisis caused across a broad spectrum of the economy. The stock market, for instance, lost 60 percent of its value, millions of jobs vanished, with full-time employment still below precrisis levels, and the system itself lost public confidence that it has yet to regain.

In the most recent reminder, American International Group, the insurer which teetered on disaster due to losses from the type of insurance it sold against defaults on subprime mortgages, won a controversial lawsuit in which it alleged the government used overreach when it effectively seized the firm in 2008.

However, AIG received no damages in a ruling that essentially took a no-harm no-foul stance: The judge agreed that the government lacked the authority to do what it did, but said the actions resulted in no material harm to shareholders, who could have been wiped out had the firm not been saved.

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For its part, the Richmond Fed warns against the dangers of what can happen when big financial institutions expect an endless backstop.

"When creditors expect to be protected from losses, they will overfund risky activities, making financial crises and bailouts like those that occurred in 2007-08 more likely," the Fed said on its website. "An extensive safety net also creates a need for robust supervision of firms benefiting from perceived protection. Over time, shrinking the financial safety net is essential to restore market discipline and achieve financial stability. Doing so requires credible limits on ad hoc bailouts."

In the wake of a crisis that saw deposit insurance jump from $100,000 to $250,000, the Fed step in to protect creditors of Bear Stearns and Lehman Brothers, and the Treasury protect shareholders of money market mutual funds, legislators took various actions to try to prevent future crises.

The most prominent was the Dodd-Frank legislation, which enacted provisions to unwind systemically important banks in case they get in trouble. However, analysts at the Richmond Fed believe that while the act may somewhat diminish the possibility of future cash injections or outright bailouts, it "likely will have less impact than some observers might hope."