By L. Randall Wray
As I reported over at Great Leap Forward,a new study by two UMKC PhD students, Nicola Matthews and James Felkerson,provides the most comprehensive examination yet of the Fed’s bail-out of WallStreet. They found that the true total cumulative amount lent and spent onasset purchases was $29 trillion. That is $29,000,000,000,000. Lots of zeros.The number is quite a bit bigger than previous estimates. You can read the first of what will be a series of reports on their study here: I want to be clear that this is a cumulative total—and for reasons I willdiscuss in this post it is the best measure if we want to understand themonumental Fed effort to restore Wall Street to its pre-crisis 2007 glory.
It is certain that no government anywhere, ever, hascommitted so much to benefit so few. Wall Street owes the Fed a big fat wetkiss. That’s a kiss Chairman Bernanke apparently does not want.
Last week he extended the Fed’s veil of secrecy over itsbail-out of Wall Street by trying to counter a recent Bloomberg analysis of theextent of the Fed’s largess with a fog of deceit. Apparently the Chairmanforgot the lesson we learned from Watergate: the cover-up is always worse thanthe original indiscretion.
Bloomberg had found that the Fed committed $7.77 trillion tothe biggest banks. Bernanke provided a memo that claimed the real total wasonly $1.2 trillion. The memo went on to argue that much of the Fed’s lendingbenefitted small banks, recipients of student loans, and even manufacturingfirms like Harley Davidson. Finally, it claimed that throughout the bail-out,the Fed’s actions were transparent, with Congress continually updated on theFed’s actions.
It was quite a performance, reminiscent of the kind ofmisleading statements the previous Chairman, Alan Greenspan, made before theHouse under interrogation by the late, great, Representative Henry B. Gonzalez.Gonzalez—trying to shine a bit of light into the Fed’s secret meetings—askedwhether the Fed kept tapes of its FOMC meetings (shades of Watergate).Greenspan fibbed, answering “no”. Realizing that it is not a good idea to lieto Congress, he went back to the office, convened a conference phone call ofFed officials and warned them that they likely all would be called beforeGonzalez’s committee. He said it would be up to them to decide to tell thetruth, or to continue the charade.
You see, the Fed did tape every meeting andhad been doing so since the days of Watergate; but the tapes were transcribedand then (supposedly) erased and used for subsequent recordings. In the end,the Fed decided to tell Congress the truth, and agreed to release editedtranscripts within 5 years. Soon some generous interpretation, Greenspan’s fib was not a lie.
You can now read them on-line. (See the FOMC transcriptsthe period from October 1993 to May 1994 for discussions surrounding the wisdomof operating with greater openness—and for fascinating internal discussionsabout how to deal with González and Congress; see also my article
However—and this is a real scandal—the Fed is routinelyshredding all the original transcripts (only the edited versions areavailable). You see, the Fed claims that because it is “independent”, it is notsubject to normal sunshine laws that require maintaining government records.And its meetings that discuss monetary policy and bank supervision are alsoexempt from sunshine, according to the Fed.
But that is a topic for another day even though it should be infuriatingto Congress.
Let us get back to Bernanke’s 29 trillion dollar white lie.First, it simply is not true that the Fed willingly provided information on thebail-out to Congress. In fact, Bernanke repeatedly refused to provide anythingto Congress regarding what the Fed was doing in secret behind closed doors. Ittook a courageous effort by Senator Bernie Sanders to force the Fed to releaseinformation, as Bernanke fought tooth and nail to keep all its dealings secret. (SeeMat Stoller’s excellent piece that describes the whole effort to fight back by theFed and its stooges)
Even after Senator Sanders’ amendment to require an audit won—on a 96 to 0 votein the Senate–the Fed released only aggregated data, making it impossible toidentify the Fed’s chosen winners. But once Senator Sanders got that datareleased, Bloomberg was able to put together a successful Freedom of InformationAct lawsuit to force the Fed to release data on bail-outs given to individualinstitutions. Still, it was provided in a way that made it as difficult aspossible to total amounts provided—so Bloomberg helped enormously by puttingthe data into a usable format.
That is what has led several groups of researchers tofinally begin to analyze exactly what the Fed did—including researchers at UMKC.And what the Fed did stinks to high heavens. It would be hard to find anyaction by any governmental agency in history that has provided more benefit toa handful of favored institutions and individuals. Matt Taibi has identifiedthe “Real Wives of Wall Street” who got nonrecourse low interest loans so thatthey could reap huge risk-free benefits. The GAO totaled the Fed’s bail-out at$16 trillion (but this excluded some of the Fed’s special facilities, mostnotably its emergency loans to foreign central banks—including loans to prop-upColonel Gaddafi’s central bank, as discussed below). TheFed lent to its member banks but also went far beyond that to lend to domesticshadow banks as well as foreign governments.
And at Senator Sander’s request, the Congressional ResearchService investigated the direct subsidy given to the biggest banks, as the Fedprovided near-zero interest rates so that they could play the yield curve,buying Treasuries. As the Senator said, “This report confirms thatultra-low interest loans provided by the Federal Reserve during the financialcrisis turned out to be direct corporate welfare to big banks.” The recent Bloomberg estimated the subsidy tolarge banks at $13 billion. Othershave come up with bigger numbers—Ed Kane estimates it at more than $300 billionannually.
Chairman Bernanke responded with a letter to both the Houseand the Senate objecting to these findings. He then attached an unsigned memoto counter the findings. (see here)It is actually a strange memo, as Felix Salmon argues. Presumably, Bernanke wanted to maintain some distance from the unsigned memo—followingOllie North’s “plausible deniability” tactic–if it was found to be materiallymisleading or just downright dishonest, he could object that he never reallyendorsed it. As Greenspan understood, it is not a good idea to lie to Congress.
In any case, a central conceit of the memo is that the Fednever had more than $1.2 trillion in loans outstanding at any point in time. Itclaims that the higher estimates provided by others come from “egregiouserrors”, likely by using a cumulative measure. That is, instead of taking thepeak lending at an instant of time, others have added up across a series ofrevolving loans. The memo goes on with a neat little analogy. Say you purchasea house with a mortgage of $200,000; but later you refinance themortgage—retiring the original and taking out another $200,000 mortgage (onmore favorable terms). Then if we total the two loans, we get total lending of$400,000. Obviously that would be a highly misleading measure of how much youborrowed from your bank.
True enough, but it is not a relevant example. Over at myGLF blog, I provided a more telling analogy. Say you’ve got six drunk bankersat the bar (named Goldman, Morgan, Stanley, Fargo, Citi, and BoA, for example).Each has a shot glass that Ben the bartender keeps filled. Bernanke would saythat Ben the bar-keep has only provided six ounces of booze since there isnever more than six full glasses at any point in time. Ben fills the glasses,oh, 29 trillion times over the course of three years. Still, Bernanke claimsBen never contributed to the drunkenness of bankers since he never providedmore than six ounces of booze at a time.
Obviously, it is not the relevant measure of the Fed’s contributionto drunken bankers. Claiming that the Fed “only” lent $1.2 trillion maximum atany particular instant over the past three years does not tell us much. Nordoes it really reflect the way the banks view the matter.
You see, bankers look at Fed lending the way a drunk looksat a free shot glass of whiskey. It fuels the drunk.
Don’t take my word for it. A banker put it to me this way:
“I was buying short term securitiesthat yielded about 12%. My choices of funding were CDs at 0.5% and the Fed at 0.35%,so I funded at the Fed. I funded my bank’s $80 million of AAA 9 month CMBSsecurities at the Fed. I could have used FDIC insured deposits but the Fed wasa tad cheaper. Banks use the cheapest funding available.”
To translate that: banks could have funded commercialmortgage backed securities with certificates of deposit insured by the FDIC, orby borrowing using the Fed’s special facilities. But bankers aren’t dumb; well,OK they are dumb, but they aren’t thatdumb: They know better than to look a gift horse in the mouth. As SenatorSanders argued, the Fed’s special facilities gave them the cheapest fundingavailable – as the bankers acknowledge. And the Fed very nicely extended the cheapest funding to the RealHousewives of Wall Street, foreign banks and central banks, hedge fund managers, and – apparently – just about anyone among the top 1% who wanted a cheap loan.
(One recalls Representative Charles Rangell’s comment whenhe found out about special deals the old Resolution Trust Corporation washanding out to President Bush’s (senior) pals: why is it only white folks thatget these deals?)
Now I want to be fair to bankers—at least to the honest onesin the bottom 4,990 of our 5,000 banks, since the top ten banks seem to be runas what my colleague Bill Black calls control frauds. If the Fed offers thelowest cost of funding, you go to the Fed to fund your position in assets. Andyou make out like a bandit when you can fund at 0.35% and earn 12%.
How can youblame them?
No, you must blame the Fed. The Fed is not supposed to bethe low cost source of bank funding—something Bernanke well understands. AsWalter Bagehot proclaimed more than a century ago, in a crisis the Fed must actas a lender of last resort, but that lending MUST be expensive and temporary.Nowhere in the Fed’s mandate did Congress tell it to act as the lowest costsource of funding. Perhaps that would be a good policy, worthy of Congressionalconsideration. But I’m pretty darned sure that Congress will be horrified tofind that the Fed has unilaterally adopted this as its third mandate (alongsideprice stability and high employment).
By contrast, Congress did explicitly decide to subsidizebank funding when it created the FDIC. By guaranteeing bank deposits, Congresslet banks fund by issuing liabilities that are essentially as safe asgovernment IOUs (and, indeed, since the Treasury stands behind them, they are effectivelyUncle Sam’s IOUs). As the banker told me, banks had the choice of using theCongressionally-supplied subsidy on insured deposits, or the Fed’s subsidy onlending through its special “emergency” facilities. They chose the Fed’s biggersubsidy as the cheaper option. An option never approved by Congress. An optionthat is not within the Fed’s legal mandate. An option that the Fed should neverprovide.
Butit did. It made $29 trillion worth of lending plus asset purchases. The cumulativetotal is a good, indeed, precise, measure of the amount of these “emergency”interventions to help financial institutions. And it went on for threeyears–even four—with “lender of last resort” low cost funding.
Andnote that the Fed’s subsidized funding of banks puts the Treasury at the samerisk that FDIC-insured deposits put Uncle Sam. If a bank goes under, theinsured deposits are covered by the FDIC and backed by the Treasury. And if thebanks’ borrowing from the Fed had gone bad, causing Fed losses, the Treasurywould have taken the hit. This is because the Fed pays profits to the Treasuryand if profits disappear (and, worse, if losses are incurred) it is theTreasury that takes the loss.
(Update: An anonymous blogger sent me the following email,which I have not been able to check out. It seems to strengthen my claim sincethe losses go directly to the Treasury: “In terms of accounting, the Fedchanged its rules this past January to free itself from worrying aboutsolvency. The change essentially allows the Fed to denote losses by the variousregional reserve banks that make up the Fed system as a liability to theTreasury rather than a hit to its capital. It would then simply direct futureprofits from Fed operations toward that liability… “Any future lossesthe Fed may incur will now show up as a negative liability as opposed to areduction in Fed capital, thereby making a negative capital situationtechnically impossible,” said Brian Smedley, a rates strategist at Bank ofAmerica-Merrill Lynch and a former New York Fed staffer. Paying back the negative liability could impact future Fed earnings rebatesto Treasury (though the Fed governors could, and as a political matter,probably would continue paying the rebate). But beyond that point,Treasury’s negative capital position would be noncollectable and exempt fromthe debt ceiling. So it’s like loading debt onto a rocket and shooting itinto the Sun.”)
Now, Bernanke’s memo claims that the Fed did not sufferlosses, indeed, made profits on the loans. This appears to be almost true—thereare still outstanding Fed commitments (loans and assets purchased under variousfacilities amounting to almost a trillion dollars), including some really nastyones due to the AIG fiasco, so we won’t actually know for some time.
But let ussay that once all the commitments are wound down, the Fed really does reapprofits. Does that validate ex post what the Fed did? Of course not. Clearly,things could have gone the other way. And they still might. You don’t handthose six drunk bankers the keys to their cars and then congratulate yourselfif they manage to drive home without an accident. No, you count yourself stupidlucky.
Here’s the question. Can we continue to rely on stupid luckypolicy at the Fed? After pouring $29 trillion into the glasses of drunkenbankers, is it time to rethink the role of the Fed? Is it proper for the Fed tobe the lowest cost source of booze to fuel the drunks on Wall Street? Will wejust let the Fed do this until the drunks wreck their cars?
Oh, wait aminute—didn’t they just wreck the whole global economy? Are we going to let theFed help them to do it again?
Now why do the banks need cheap Fed whiskey? Because therearen’t enough insured deposits to finance bank positions in all the toxic wasteassets they created. Before the GFC, they funded those risky positions in“markets”—by issuing uninsured liabilities (uninsured deposits, short-termcommercial paper, and other subordinated debt). But “markets” got wise to thefact that bank assets were trash, so they refused to continue to providefunding. It took $29 trillion of Fed lending and trashy asset purchases to keepthe banks funded. The way the banks looked at this was as a source of cheap,continuous funding that could be rolled-over as necessary—$29 trillion worth. Andwith no market discipline and not even superficial supervision by the Fed thatplayed the role of dupe of last resort.
And that is why $29 trillion is the right number to use. Itis the total commitment required by the Fed to save Wall Street. So far.
After my blogs and the release of Felkerson’s working paperat Levy we got a lot of expected push-back by market insiders and economistswith strong links to the Fed. For example, James Hamilton (who admits to workingfor the Fed for the past 20 years—one of the many economists around the countrywho are in the Fed’s stable of economists whose research is regularly funded)criticized us as follows:
“Felkerson takes the grossnew lending under the Term Auction Facility each week from 2007 to 2010 andadds these numbers together to arrive at a cumulative total that comes to $3.8trillion. To make the number sound big, of course you want to count only themoney going out and pay no attention to the rate at which it is coming back in.If instead you were to take the net new lending under the TAF each weekover this period– that is, subtract each week’s loan repayment from thatweek’s new loan issue– and add those net loan amounts together across allweeks, you would arrive at a cumulative total that equals exactly zero. Thenumber is zero because every loan was repaid, and there are no loans currentlyoutstanding under this program. But zero isn’t quite as fun a number with whichto try to rouse the rabble.”
Note the very nice characterization of Fed critics as“rabble”. Hamilton and Fed-funded insiders try very hard to claim that anyonewho would criticize the Fed’s bailout is incompetent, unable to tell thedifference between a stock and a flow.
Hisuse of the word “rabble” to describe me and fellow critics is yet anotherexample of the way the top 1% and its sycophants look at the rest of us—the99%. Hamilton’s statement reminds me of a talk my colleague Bill Black gave theother day at UMKC on Citigroup’s infamous “Plutonomy Memo” to its richestclients, celebrating the rising inequality of US society. Or the internalemails at the ratings agencies joking that they might as well have cows do thecredit ratings on securitized crap.
It’s really nice to get a window on the way that Hamiltonviews us– “rabble” 99 percenters. Personally, I like the label—let’s wear it.
Also note how silly Hamilton’s argumentis: net lending is zero on loans that are rolled-over, hence we must logicallyconclude that the Fed actually lent nothing, did not bail-out financialinstitutions, and that Wall Street resolved its problems with no help from theFed at all! Nice hat trick, rabbit!
The insiders really know how to manipulate the facts. Anothercritic who does not have the guts to use his/her real name but uses the handle“Alea” sticks very close to talking points:
“You (and your students) stilldon’t get the difference between “Term Adjusted” and “Not TermAdjusted”. On a “Not Term Adjusted” basis (the way GAO gets $ 16trillion and $26 trillion with swaps) a bank borrowing $1 bln for a one yearterm counts for less than one that borrows $1 bln overnight rolled over twice,that’s absurd. These loans aren’t cumulative, they are rolled over (paid backat the end of each term).”
She or he has repeated this mantra at several blog sites.Look, we get it. But this is a bait and switch complaint. Banks facing a liquidityshortage should have access for overnight lending at the Fed—say, $1 billion,due tomorrow, at a penalty rate. And maybe they need to roll it over a night ortwo. But the Fed is NOT supposed to lend for a year! This is emergency lending,after all. It is supposed to be temporary and expensive. But in fact, the Fedlent “overnight” on a repeated, chronic basis because banks could not fundthemselves in markets at the interest rate they desired. So the Fed“accommodated” by pouring the cheap whiskey over and over and over—for weeks,months, even years on end. To get a measure of this chronic abuse of overnightlender-of-last-resort facilities it doesmake sense to add up across the loans.
That is a far better measure of the extent of the Fed’sefforts to bail out troubled banks—who should be expected to fund themselves inmarkets, not at the lender-of-last-resort!
I love the comments by a self-described “liberal” who goesby the pseudonym “rjw.progressive”:
“I’d be really curious to learnwhere you learned your banking stuff from. I didn’t see anything especiallybanking related on your CV…. Maybe things have changed big time since Ipracticed banking law (corporate and int’l lending, trade finance and reg comp,mainly) from the 70s to 90s for a money center and then super-regional bank,but I suspect not when it comes to the basics. For the purpose of analyzingbanking and the Fed’s support thereof, do you understand that there aresignificant differences between secured lending and unsecured lending? Betweenthose sorts of lending and commercial paper facilities? And between those andcurrency swap facilities?”
Sniff, sniff. Yes, right, I never worked for the Fed or fora money center bank. I think I pretty much screwed the pooch so far as thosecareer options go when I co-wrote an article back in 1994 arguing that ChairmanGreenspan was “flying blind”. And I don’t think BofA has been too thrilled with recent pieces I wrote with mycolleague Bill Black about its foreclosure frauds. I learned my “banking stuff” from Hyman Minskyand have published many scholarly articles on money and banking, but I neveraspired to shill for the Fed or Goldman.
In any case, the relevant question about “secured lending”is: secured by what? Trash rated Triple A by S&P’s “cows”? How’s that working outfor y’all?
And on the “currency swap facilities”, this was dollarlending by the Fed against foreign exchange, with the borrowers promising torepay in dollars at a fixed exchange rate. Therefore, no risk to the Fed. Right!Wanna buy a Brooklyn bridge?
Peakexposure in the currency “swaps” was nearly $3 trillion, and total cumulative“swaps” were $10 trillion. These “central bank liquidity swaps” actually do notentail too much risk because the foreign central bank only promises to deliverits own currency to the Fed (the Fed credits the foreign central bank’s accountwith dollar reserves; the foreign central bank credits the Fed’s account withforeign currency reserves; and the deal is unwound by the Fed debiting thedollar reserves and the foreign central bank debiting the Fed’s foreigncurrency account). The idea is that a foreign central bank could always creditthe Fed’s account with the foreign currency reserves, so risk is small.
Thisis true. It is the foreign central bank that takes counterparty risk indollars—as it lends dollars to private banks—and even if it takes a loss thatdoes not hinder its ability to pay the Fed in the foreign currency.
Theonly significant risk is that the foreign central bank might simply decide totell the Fed to take a hike.
Thatis admittedly not very likely, especially since most of the Fed’s lending wasto the ECB. If the Fed lends to Greece, then there is indeed risk because ifGreece leaves the EMU it is not likely to pay promised euros to the Fed. Or, ifthe Fed lent to an irresponsible government facing very high inflation(Zimbabwe, anyone?) it might refuse to pay the promised gazillions of domesticcurrency due to maintain a fixed exchange rate in a rapidly depreciatingcurrency.
Further, the frequent claim that the Fed only lent to healthybanks and on good collateral is belied by the following: “Dexia of Belgium and Depfa of Germany, twobailed-out European institutions, took $50 billion in loans on a single day inOctober 2008 when the interbank lending market seized up”. Dexia? No riskthere, right? Nice well-run institution worthy of the trust of our Fed.
Many justify theFed’s lending on the argument that things turned out more-or-less OK. EvenGadhafi made good. But like the drunks with car keys, that is ex postjustification. The ex ante risk was real.
To be clear, evenif no risks were taken and even if the Fed makes profits on every single deal itmade, I would still object that the Fed has no business lending to Gadhafi. OrDexia. Or any insolvent US bank. Or any solventUS bank on a continuing basis. Or any solvent bank on concessionary terms.
The Fed issupposed to operate in the public interest. The American public, that is. Including the 99% “rabble.” Emergencylender-of-last resort lending to US member banks is clearly in the publicinterest. On a temporary basis, at a penalty interest rate. After that, if thetroubled bank cannot find market funding, it should be resolved.
To be clear, my complaint is not really about risk exposure.Yes, the Fed can lend trillions of dollars and it can buy trillions of dollarsof dodgy assets through “keystrokes” as Bernanke (rightly) calls them. And ifthe Fed loses trillions on its bets, these can be covered over by trillions ofdollars of bail-outs by the US Treasury. There is no limit to the Treasury’sability to paper over Fed losses. It is a sovereign issuer of the currency, asall MMTers understand.
And it ain’t just crazy bloggers who accuse the Fed of badbehavior. Senator Sanders had the Government Accountability Office investigatethe Fed; after reviewing the resulting report he found that:
The GAO detailed instance after instance oftop executives of corporations and financial institutions using their influenceas Federal Reserve directors to financially benefit their firms, and, in atleast one instance, themselves. “Clearly it is unacceptable for so few peopleto wield so much unchecked power,” Sanders said. “Not only do they run thebanks, they run the institutions that regulate the banks.”
Big losses at the Fed would be a public relations disaster,at best. It would likely lead to a huge political reaction against the Fed. Sowhile credit risk to the Fed should not be the major reason for objecting towhat the Fed did, it should be of some concern.
Congress should immediately call Chairman Bernanke in fortestimony on the veracity of the Fed’s response to the Bloomberg report. Itshould demand a comprehensive accounting for all the Fed’s commitments, byinstitution that benefitted. Bernanke should explain what the Fed did, when itdid it, why it did it, and in whose interests it has been operating since theGFC began. No more obfuscation. No more secrecy. No more fog of deceit.
And it should make the Fed subject to sunshine laws. Thereis no excuse for destruction of transcripts. There is no excuse for secrecyabout actions taken 3 years ago. Release all the information. Answer allquestions. Truthfully, openly, completely.
Or Congress should shut the Fed down. The notion thatrelease of the Fed’s secret information will shake markets no longer holdswater. The cat is out of the bag—the continued cover-up is destroying trust,not only in the Fed and in our banks but in our markets, our government, oureconomy.