Fed Profits From The Bailout? Don’t Count Those Chickens Before They Hatch

A flurry of reports appears to indicate simultaneously that the government’s bailout of Wall Street is working to bring banks back to life, and that the Fed is making profits on the deal: See for instance here, here and here. According to these reports, the Fed received $19 billion in interest on its emergency loans to troubled institutions, which was about $14 billion more than it would have received if it had instead bought Treasuries. In addition, it was reported that the Fed made $4 billion of profits from the eight largest banks that have repaid TARP funds. This is seen as good news in Congress: “The taxpayers want their money back and they want the government out of our banking system,” said Representative Jeb Hensarling.

There are three fundamental problems with these stories. The first is that it raises a question about the function of the Fed: should a branch of government seek profits at the expense of the private sector? As we all know, the Fed is normally profitable and returns earnings above 6% on equity back to the Treasury. When the Fed profits on its holdings of government debt, that is essentially the government paying itself and thus of no consequence. Profiting at the expense of private institutions—even if they are the hated “banksters” of Wall Street—doesn’t seem to be something to celebrate. Especially when we are in a deep recession or depression, with a long way to go before the financial system recovers. All else equal, I’d rather see the private sector accumulate some profits so that it can recover.

Don’t get me wrong. I want retribution, too. We need a “bank holiday”, to begin next Friday: close suspect banks including all of the biggest that were subjected to the wimpy “stress test”. Spend the weekend going through the books and then on Monday begin to resolve the insolvent, to prosecute the banksters for fraud, and to retrieve from them their outsized bonuses financed by the public purse. It is payback time. My only objection is to the notion that we should be celebrating because the Fed appears to have made a profit on (a small part of) the bailout.

Second, there is every reason to suspect that the banks that have repaid TARP money and those making payments on loans from the Fed are still massively insolvent at any true valuation of the toxic waste still on their balance sheets. Recent reported profit in the financial sector is window-dressing, designed to fuel the irrationally exuberant stock market bubble. This will allow traders and other employees to cash in their stock options to recover some of the losses they incurred last year, even as bonuses are boosted for this year. Indeed, the main reason for returning the borrowed funds is to escape controls on executive salaries and bonuses. And, finally, it provides some important PR to counteract the growing anger over the financial bailouts. Only the foolish or those with some dog in the hunt will believe that the banksters have really managed to restore health to the financial sector as they continue to do what they did to cause the crisis.

Last but not least, the Fed’s “profits” are based on an infinitesimally small fraction of its ramped-up operations—its liquidity facilities (that also include discount window loans and currency swaps with other central banks, purchases of commercial paper and financing for investors in asset-backed securities). It has also spent $1.75 trillion buying bad assets, with any losses on those excluded from the profits numbers. The government’s profits also exclude current and expected spending on the rest of its reported $23.7 trillion dollar commitment to the financial bailout and fiscal stimulus package. The failure of just one medium-sized bank could easily wipe out the entire $14 billion of profits that has attracted so much notice. (See also Dean Baker on the government’s “profits”)

It is ironic that Euroland’s regulators are calling for much more radical steps than Washington is willing to take. German Chancellor Angela Merkel and French President Nicolas Sarkozy are calling for more regulation and for limits on executive compensation even as the Obama administration continues to argue that such limits would constrain the financial sector’s ability to retain the “best and the brightest”. If the bozos that created this crisis are the best that Wall Street can find, it would be better to shut down the US financial system than to keep them in charge. It is doubly ironic that Nigeria (a country that normally would not come immediately to mind as a role model) has actually charged the leadership of five of its major banks with crimes. Each of these banks had received government money in a bailout, and the CEOs stand accused of “fraud, giving loans to fake companies, lending to businesses they had a personal interest in and conspiring with stockbrokers to drive up share prices.”

Isn’t that normal business practice for Wall Street banks favored by Ben Bernanke and Timothy Geithner? It is time to get the NY Fed out of Goldman’s back pocket, and to permanently downsize the role played by Wall Street and the Fed in our economic system.

5 responses to “Fed Profits From The Bailout? Don’t Count Those Chickens Before They Hatch

  1. There are various historical precedences with good outcome of central banks making investments at the bottom of a down turn to help put a floor on asset price. In the final analysis, the tax payers win multiple times over.1. The severity of the down turn is tempered.2. Because the investment were made near market bottom, years later the investment becomes a huge windfall for the public coffer.The most recent example is Hong Kong's handling of the Asian financial crisis of 98. The Hong Kong central bank step in and directly purchased stocks on Hang Seng stock market. At the time the market was 1) under sever general panic and was also 2) under sever speculative attack. Partly because of the central bank action, the Hong Kong economy fare much better than the neighboring countries. While the people suffered but they've suffer less. Furthermore a few years after the crisis, the assets held by the Hong Kong central bank doubled in value. The HK central bank didn't intend to make money. However, the investment gain is still a huge win for the tax payers nevertheless.I am actually very bullish on the outlook of the current Fed's assets. Investing near the bottom of a crisis in the US has always resulted in out sized returns for the entire history of US. Furthermore, unlike individuals, the government has a very long time horizon. Of course, this stuff is not a sure thing. However, the odds are excellent.

  2. "If the bozos that created this crisis are the best that Wall Street can find, it would be better to shut down the US financial system than to keep them in charge."LOL! btw I have never heard anyone else in the mainstream make this (what should be) obvious point!

  3. Thank you for the salient points that need to be touted with much greater frequency. Another blogger recently made the connection of how the "FED" is so wired into mainstream academia and commerce, virtually controlling the 'economic-speak' and "group-think"in most circles. (AKA – mass propaganda & hypnosis) Perhaps it was a slip up in this post that the FED was alluded to as a 'branch of government.' It makes for clearer understanding of how things work and is worth noting that the "FED" is more aptly described as a banking cartel that operates under congressional authority. Below is an amalgamated definition as seen in Random House & Webster's dictionaries. CARTEL 1. a syndicate, combination of independent businesses, or trust formed to regulate, production, prices and marketing of goods by its members in some field of business.2. a coalition of political or special-interest groups having a common cause, as to encourage the passage of a certain law. When one considers America's tenuous relationship with central banking apologists and the historical struggles in which our country has engaged with those interests in its history – and when one further investigates the banking interests that colluded to create the "FED" and the manner in which it was carried out and implemented along with the resultant and extant evidence for its many failure as an institution (to keep inflation in check for instance), it makes one stop and think; and agree that it needs to be routed out and certainly should be taken out the back pocket of Goldman and their insider-trading cronies.E.JohnsonThe Financial Independence Project

  4. Thanks for comments.1. Hong Kong is a tiny place that relies on the rest of the world to pull it out of its crises; the US cannot follow that example.2. Yes, it is an uphill battle to downsize finance. And the Benny-Timmy-Larry team is maintaining exactly the opposite policy.3. Of course a branch of gov't can be captured by private interests. The Fed is a creature of Congress, created by 1913 Act, and subject to any further laws Congress might enact to guide its policy. It also must coordinate with Treasury (to ensure checks don't bounce, and so on). Much of its policy-making is done in secret–which might be a violation of US laws. If you read the transcripts (which appear to be accurate), it looks like the FOMC behaves more responsibly than you might imagine (I wouldn't have adopted the same policy, but it looks above-board). The NYFed is probably a different can of worms as it appears to be completely captured by Wall Street. Personally, I would greatly reduce the Fed's role in the economy, including taking away its ability to set overnight rate targets (I would peg it at zero, permanently). I would get it out of the bank supervision business (because it does such a horrible job). I might keep the district offices and direct them to conduct research of local conditions. We need lender of last resort interventions and it is possible that Washington is the best place to house that function. Ownership of the Fed by private banks is anachronistic and might be discontinued. LRWray

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