About TARP, It's Not Inflationary If Banks Do It?

By way of Digby, we come across Atrios' excellent summary of the TARP program:

It's a little weird that reporters are hesitant to clearly spell out what happened. Basically the Fed printed a huge amount of money. Some of that money they used to do what TARP was originally supposed to do, buy up Big Shitpile at inflated prices. Some of that money they lent to banks at basically 0 interest. Of course there were plenty of other things they could have done with 2 trillion bucks, if preserving the executive compensation at megabanks wasn't thought to be crucial for the survival of the economy. They could have dropped it from helicopters. They could have paid off mortgages directly. They could have given it to state governments. They could have bought me a SUPERTRAIN. But, no, they decided that propping up an obviously failed system of financial intermediaries was the important thing, so that's what they did.

But there are two points worth highlighting.

First, this money came with no strings attached, unlike any other federal contract. If we gave someone $5 billion to build bridges, there are all sorts of specs and regulations that have to be met (unless you're a Too Big Too Fail Contractor like Halliburton). Hell, the regulations for a dinky little NIH grant are pretty complex. And nobody dies if an NIH grant falls down. Yet, TARP recipients got this money with virtually no guidelines. Everyone was told this would allow banks to start lending again, although it was obvious they weren't going to do that, unless ordered to do so.

Which brings us to the second point: this is an inflationary scheme designed to save the banks. Suppose I'm a bank with a $10 billion hole in my balance sheet. I go to the Fed and get $10 billion dollars. What's the surest way to turn that $10 billion into rock solid assets? Buy T-bills--that is, loan it right back. After a year, the Mad Biologist's bank not only replaced a $10 billion dollar hole with cash, but we made around $300 million on the interest.

Now, this doesn't really increase the deficit. After all, we 'paid back the money.' However, what this does is increase the money supply. We've just created $10.3 billion out of thin air. That's not necessarily a bad thing, if we were to point that money towards something truly useful (SUPERTRAINS! I CAN HAZ MOAR GENOMZ?). We could have said that employees won't have to pay payroll taxes for the next three years, and printed more money to cover the shortfall, for instance. But we didn't. Instead, we decreased the value of everyone's savings and wages. To help the FIRE sector. The idiots who got us into this mess in the first place.

So, I guess INIIBDOI (It's Not Inflationary If Banks Do It).

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Do a comparison between the size of the banking problem, and the size of government debt.

You will find the banking problem is peanuts, particularly because the lending via the TARP can be recalled. ie. Funny money against funny money. The nett effect is small.

However, the size of government borrowing dwarfs that number by orders of magnitude.

You've fallen for the oldest political trick in the book, "blame someone else".

It's a distraction technique. Look at here. Look at the mess in the banks. Er, but I want to look at your debts....

Nick

I'm consistently surprised that people are re-re-re-discovering the fact that a bailout amounts to giving free money to people who don't deserve it because the consequences of not doing so are worse. Yes, that's a bad thing and it it makes us all said (frowny face). But the fact is, spending the same few billion dollars on a mag-lev train to nowhere simply wouldn't have stopped the collapse of the financial system.

I'm all for stimulus spending when monetary policy loses traction. I would have been all for a much more brutal form of "bail out" involving taking failed investment banks into receivership and winding them down after wiping out shareholders. That being said, it's nuts to think that we could have let the financial system totally melt down and spent the bail out money on stimulus projects and gotten the same results without the moral hazard.

By Troublesome Frog (not verified) on 06 May 2010 #permalink

Order of magnitude FAIL on Nick's part. TARP amounts to a total of $2T, and at that it may be dwarfed by the derivatives problem--I have heard estimates that the gross amount may be ~$1 quadrillion, and while in principle most of the bets are offset by contrary bets, it wouldn't take much of a rounding error or insolvent counterparty issue to make that a big problem. The annual government deficit is still less than $2T--not by much, admittedly--and a big chunk of that is going towards programs that actually help ordinary people. TARP doesn't do that; instead it preserves bonuses for a class of people who get paid to insert their sticky fingers into any stream of cash that may be flowing in their general direction. The next time you visit a marina in the Hamptons where Wall Street titans park their yachts, ask yourself where the customers of said Wall Streeters park their yachts.

There is an argument to be made that we had to do something along these lines, and Troublesome Frog tries to make that argument. There was a significant risk of deflation, and that would have been bad news for many innocent bystanders. We did not, however, have to turn it into a pure giveaway.

By Eric Lund (not verified) on 06 May 2010 #permalink

It seems also that he conflating a few different programs that were funded in different ways. The $700 billion TARP funds were borrowed funds, and were spent by the Treasury. Some of that money (but hardly all) has been paid back. Some of the other funds, like the Fed's TALF program, and the $1.25 trillion in MBS purchases, were funded by expansion of the Fed's balance sheet--i.e., printing money. There were other forms of aid, like the FDIC's guaranteeing $300 billion in Citi bonds, that did not involve direct cash payout (yet).

Why shouldn't the CEOs get their bonuses? They did their jobs well - they protected shareholder value by successfully recapitalizing their companies on extremely generous terms. It would have been nice enough for the gov't to buy assets at the spot price since limited liquidity would have certainly meant that they wouldn't sell on the open market unless they were below it at the time, but they frequently got Paulson to over around 40% extra. Sucks to be you if you're not a shareholder, but that was some pretty impressive foisting of risk onto taxpayers' backs.

You and Atrios seem to be confused about the accouting of TARP - the Baker article that Atrios draws on is a bit of simplification and it seems to have telephone-gamed pretty badly.

The TARP funds came from the Treasury, and thus were raised primarily by the issue of t-bills (the treasury does engage in seigniorage, but it's small relative to TARP, let alone the whole budget). First, and most significantly, these funds were used to buy preferred stock, which lies between debt and common stock in terms of risk. If a bank sells preffered stock to the Treasury and buys t-bills with the proceeds, then buys back the preferred stock with the t-bill yields, the net effect is to have moved default risk from the bank's shareholders and creditors to the Treasury temporarily. This isn't obligately a profitable deal for the bank unless the terms of the preferred stock make it so that it's yield is less than the treasury yield plus it's risk premium, but Paulson saw to it that the terms were indeed quite favorable to the banks. It wasn't strictly deficit increasing since the companies have been good about buying back the stock so far, but the goverment could have held assets that were both less risky and more profitable.

The PPIP program is part of TARP and does something similar to TALF (see below) with Treasury funds, but is smaller than the intial actions and came much later.

TALF, which is an different bucket of crap but often gets conflated with TARP, is a unilateral Fed program to buy shitty assets with the Fed's reserves. The Fed controls the money supply because banks are forced to hold some money in reserve with them, and it either sits on that money or lends it out depending on how much money it feels should be out there. The fed took a whole bunch of this money and bought risky assets so their holders wouldn't have to deal with them - this is inflationary, since that money would not see the light of day otherwise, but in the same way as normal open market operations. The Fed has made money on these risky assets so far (a housing double dip may change that), but at a much lower yield than it has on buying t-bills, which is what it normally does when it feels like releasing some reserves.

The treasury part of PPIP isn't inflationary like TALF since it's not using Fed reserves although it also involves buying crappy assets, but it likely to be debt-increasing as long as it pays the same prices as TALF since those assets were yielding at below t-bill levels and the treasury's part of the program is financed by the issue of t-bills.

Don't worry if you didn't get all that on the first pass - due to moral hazard in about 10 years we'll get to do it all over again.

Real interesting. Amusing ,too. Well, back to the weed patch. Might be a nickel or dime in there somewhere.

By John Norborg (not verified) on 06 May 2010 #permalink

The purpose of these bail-outs is to conceal for a few more years that the money in your retirement plan is not backed by any assets. IOW: the money that the law compels you to put aside each working hour gets *stolen*, pretty much immediately, by the financial system. If people really understood this, it would be mayhem.

Hence the bail-outs.