Is it fair to say that taxpayers bear risk in the Fed's bailout of Bear Stearns? The notion that the taxpayers will wind up funding the bailout is gaining traction in political circles. DealBreaker comments section regular Anal_yst, however, says that this just isn't true.
While the Fed is funded and overseen by Congress, it is "private within the Government;" it is effectively a self-funded entity operating as a "private" organization within Government. The loan extended by the Fed to JPM (via Maiden Lane, LLC) was a direct extension of credit from the Fed's balance sheet, not from an appropriate of taxpayer monies, which so far as I can tell, would have required specific Congressional action.
Overlooked here is that taxpayers have a direct interest in the Fed's balance sheet since the Fed remits excess earnings to the Treasury's general revenues. If those earnings are diminished because of the loan made to JP Morgan, the revenues will have to be made up for by decreased spending, increased debt or tax hikes. Taxpayers, as residual claimants of the Fed's earnings, will indeed end up bearing the price.
Setting the Record Straight: Taxpayers Are NOT Funding JPM's Buyout of Bear Stearns [1-2 Knockout]
Posted by guest , Jul 11, 2008 10:24AM
So what if taxpayers had to foot the bill? They have a direct interest in the stability of the financial markets. Even if they're not investors, they still have 401ks, pension funds, state retirement funds, whatever. A collapse of Bear certainly would have undermined the foundation of the financial system, so it's in the taxpayers interest to keep Bear from collapsing completely. I think Paulson did the most responsible thing by guaranteeing that Bear's price was as undervalued as possible so as to send a message that these banks could not depend on government bailouts to stay afloat. The government will help keep the system going, but it's not going to provide a cushion to shareholders. I completely agree with this.
Posted by guest , Jul 11, 2008 10:38AM
The Fed is under NO obligation to generate revenues for the Treasury. It just so happens that it does end up doing so in the normal scheme of things.
Claiming that potential non-remittance of revenue from an unguaranteed source is proof of a 'bailout' by the other revenue contributors is specious.
And if we start considering such second and third degree effects then everyone is bailing out everyone else. So if company A runs a crappy operation and hence ends up generating massive losses - thereby not contributing any taxes - then they are being bailed out by the taxpayer?
If I decide tomorrow to work for 25% of my current salary (while taking NO welfare payments or any such thing and also giving 25% of my usual output), then given that the tax revenue would go down, is the tax payer 'bailing me out'?
Posted by guest , Jul 11, 2008 11:08AM
They sould have let Bear fail. Are the markets stable now? No.
But they can't let Freddie and Fannnie fail.
Yes, taxpayers are on the hook. The Fed remits its profits to the Treasury. Profits will be lower if the $30 Billion of shit the FED is backing turns out to really be the shit we all know it is. If course Morgan is covering the first 3% in losses.
Posted by Anal_yst , Jul 11, 2008 11:08AM
@ 11:38
Thank you for saying far more elloquently what I'm getting at. I can't comprehend how some very smart people can't wrap their heads around this, arghhh!
Posted by guest , Jul 11, 2008 11:24AM
"If I decide tomorrow to work for 25% of my current salary (while taking NO welfare payments or any such thing and also giving 25% of my usual output), then given that the tax revenue would go down, is the tax payer 'bailing me out'?
"
This is dumb, you don't have the only license to print USD.
Posted by beentheredonethat , Jul 11, 2008 11:47AM
Is Anal_yst under the mistaken impression that the term "taxpayers" and "taxpayers' funds" are limited to and refer specifically to income tax receipts? Because that is not what they mean. It is inclusive of every penny the federal government has, regardless of where it is stashed. Income tax, Fica, medicare trust, leases, royalties, asset sales, usage fees, customs, FOMC operations, and every other penny that sits on the revenue side of the government's ledger(s)are taxpayer funds.
Posted by onetwo , Jul 11, 2008 11:52AM
A lot of this is going to come down to framing, rhetoric and interpretation, as opposed to factual arguments having a sound conclusion. At risk of stoking the flames of an unwinnable argument I do believe Carney is onto something with what he said. The problem isn't, say, the fed going "bankrupt" based on these loans, or an explicit "bailout", but rather this: if these securities decline in value so much that the fed is unable to continue its normal liquidity facilities then the taxpayer must recapitalize the fed's balance sheet.
Shareholder's aren't "on the hook" when a bank needs a recap/injection, but they sure as hell are the ones to suffer from poorly managed balance sheets.
None the less, like i said, this argument can go on forever. I choose to stop now.
Good work., Anal.
Posted by beentheredonethat , Jul 11, 2008 12:06PM
@11:52 you say:
"The problem isn't, say, the fed going "bankrupt" based on these loans, or an explicit "bailout", but rather this: if these securities decline in value so much that the fed is unable to continue its normal liquidity facilities then the taxpayer must recapitalize the fed's balance sheet."
The difference between recapping fed's balance sheet and bailout would be what?
Posted by Ben_H , Jul 11, 2008 12:15PM
The results of the monetary authority are generally consider "quasi-fiscal" gains or losses under standard (read: IMF) fiscal accounting. While the monetary authority's results are off-budget, they do matter for overall public sector solvency (equity position of the monetary authority is a public sector asset; negative equity of the monetary authority will ultimately need to be corrected by fiscal injection), and are considered as part of the deficit or surplus of fiscal accounts.
For an interesting example of this, look at recent fiscal results of the Dominican Republic, where the CB ran huge quasi-fiscal deficits and the recapitalization of the CB caused government debt to GDP to roughly double.
Posted by Ben_H , Jul 11, 2008 12:18PM
The results of the monetary authority are generally consider "quasi-fiscal" gains or losses under standard (read: IMF) fiscal accounting. While the monetary authority's results are off-budget, they do matter for overall public sector solvency (equity position of the monetary authority is a public sector asset; negative equity of the monetary authority will ultimately need to be corrected by fiscal injection), and are considered as part of the deficit or surplus of fiscal accounts.
For an interesting example of this, look at recent fiscal results of the Dominican Republic, where the CB ran huge quasi-fiscal deficits and the recapitalization of the CB caused government debt to GDP to roughly double.
Posted by bittergreen , Jul 11, 2008 12:31PM
No need to raise taxes or stop spending. Just tack it on to the bill the Boomers have already racked up and our handing off to their children.
Posted by guest , Jul 11, 2008 12:33PM
11:38 here.
Look, I also oppose what was done on the 'moral hazard' premise. Essentially some organizations which owes its existence to the federal government stepped in to back-stop a private entity which failed due to its own misgivings. Totally unacceptable. The very existence of the Fed and its artificial manipulation of the markets goes against the grain of a 'free market'.
However, there is no DIRECT tax-payer money involved. All that is being pointed out is the indirect impact it might have on future tax rates / government spending etc.
The Fed's efficient operation (and the revenues hence generate) provides an extra income stream to the exchequer. If is doesn't operate efficiently, well too bad!
However, nowhere is the taxpayer bailing out Bear Stearns (or the Fed). They are 'bailing out' their OWN federal spending due to deficits from revenues which were not guaranteed in the first place.
Lets say I live in the city, gamble and go into debt such that my 'rents have to pay it off, that is a bailout.
However, if I send some money to my folk's occassionally, and lets say I stop doing that because I am gambling - that is NOT equivalent to them bailing me out (irrespective of whether they have to cut back on their spending which would have in some part depended on my remittances).
Even though the end effect of both the acts is the same on the 'rents, the second is NOT a bailout of me by them.
Posted by Anal_yst , Jul 11, 2008 12:54PM
@11:38/12:33,
Again, thank you for clarifying my argument.
@ beentheredonethat
Perhaps I should have used more clear language, as what I'm referring to is explained in 12:33 more clearly, and, as 1-2 pointed out, at a certain point we're spinning our wheels in a never-ending semantic battle of interpretation and whatnot.
Posted by Ben_H , Jul 11, 2008 1:05PM
If we want to talk analogies, I think the right one here is how a subsidiary's gains or losses flow through the parent's income statement. The public fisc in a sense "owns" the Fed, inasmuch as the Fed's profits ultimately flow to the fisc. Much as there is a lot of debate about when it is proper to consolidate and when it is not, governments try to count the quasi-fiscal activities of the monetary authority when it suits them and to treat them as separate when it doesn't. What's hard for me to understand, though, is how the fisc would not be worse off if the Fed sustains a big loss.
From the IMF Manual on Fiscal Transparency:
Sec 196:
The quasi-fiscal activities of the central bank may also be difficult to identify and
quantify. Only where the financial effects are fully reflected in the profit and loss account in
the financial year in which they occur will the impact of such quasi-fiscal activities be
captured in the budget, through central bank profits transferred to the government. Even
then, the implications of individual activities for resource allocation in the economy, fiscal
risks, or the government’s prioritization of policies are not transparent."
Sec 201: "The OECD best practice guidelines do not cover reporting on quasi-fiscal activities.
However, best practice is to report quantified estimates of the fiscal significance of quasifiscal
activities, and to provide information on the basis for quantification."
Posted by guest , Jul 11, 2008 1:10PM
Wow. A civilized, informed discussion on the use of taxpayer's funds and the Federal Reserve!
I think we can all agree that $29 billion loan to JP Morgan for Bear Stearns' liabilities came from the Fed's funds, and had no direct effect on the taxpayers at this time.
I'll just add that the Fed was never designed to generate funds for the U.S. Treasury, and it's serendipity that it does. The Fed's primary purpose is to stabilize the financial system.
I have no idea what is going to be done to stabilize Fannie Mae and Freddie Mac. It seems to me that something that large will have to be done by Congress and will, unfortunately, involve the taxpayers.
Posted by guest , Jul 11, 2008 1:54PM
Ben_H, 11:33 here again.
The subsidiary analogy doesn't exactly apply to the Fed. It applies to something like the HUD wrt FHA or the DOE wrt to the fincial guarantors which guarantee federal student loans. The tax-payers have directly funds invested in that case (just like a parent would have capital invested in a subsidiary) and hence cashflows out of that subsidiary matter.
So if the HUD has to backstop (as it does) FHA losses and then that is a direct bailout by the taxpayers. The taxpayers FUND HUD and hence fund the bailout.
However, the Fed is completely self-funded not taking a dime from the taxpayers. Similarly, the 'bailout' funds also came from the Fed's pockets and not from any of the tax-payers.
In addition, NOWHERE in the entire Federal Reserve Act is generation of revenue for the Treasury a stated goal! It is after all a collection of private banks with special powers (and government appointees) as laid down in a special act of the legislature.
Essentially, it is a 'special bank' from which the government derives some 'special revenues (taxes).'
One of the stated objectives of the 'special bank' is to maintain monetary stability. In attempting to do so, it spent money and the government's 'tax share' potentially went down.
Once again, that is NOT a bailout by the taxpayers - no more than the reduction of tax revenues due to the massive losses declared by the various financial institutions is equivalent to a 'bailout' by the tax payers.
Explanation of Fed's division of earnings:
https://federalreserve.gov/aboutthefed/section7.htm
Posted by guest , Jul 11, 2008 1:58PM
Oh, and I still think that it was a 'bailout', just that I do not believe it was a taxpayer bailout where joe-schmoe 's money was being handed over to robber barons.
Posted by guest , Jul 11, 2008 2:09PM
One way or the other...joe six pack is taking this up the wazoo. Let's see how the weekend unfolds....it will be bad. Dow below 10K on Monday.
Posted by guest , Jul 11, 2008 2:22PM
Wow 2:09, so I guess you will have a great weekend as you would have shorted DOW based on your conviction.
What? You didn't do it! Why? Oh I see. You only talk.
Posted by StMarc , Jul 11, 2008 2:52PM
I haven't heard any mention of monetary inflation as a cost on taxpayers (and everybody else.)
If the Fed runs down its asset sheet, as has been pointed out, it has a license to print money (or, in these whizbang jet-speed times, to move bits in a computer to increase its account balances.) In other words, it can create money to pay its debts or cover the debts of other parties.
However, this is monetary inflation. Monetary inflation on behalf of the government can logically be referred to as an indirect tax on asset holders. Monetary inflation on behalf of third parties is just robbing Peter to pay Paul. There is no difference, practically speaking, between the Fed inflating the money supply 10% to cover bailouts and them simply debiting my bank account for 10% of its balance. It just takes longer for me to notice.
So long as the Fed has a positive balance sheet - which it does and has, although its burn rate is a little scary - I would agree that taxpayers do not bear any burden from bailouts. It merely diminishes the profits of the Fed's member banks, or the value of their interest in the Fed. The point that it might reduce Fed remittances to the Treasury is not without merit but as has also been pointed out, the Fed's not actually under any obligation to make remittances to the Treasury. Decrease in tax revenue is not the same thing as spending government money or the government directly guaranteeing debt.
M
Posted by guest , Jul 11, 2008 3:23PM
StMarc said - "Monetary inflation on behalf of the government can logically be referred to as an indirect tax on asset holders."
Small correction. It is an indirect tax on 'virtual asset' or 'fiat currency' holders. As long as you hold real assets inflation does not affect you (ok, does not affect you 'as much').
Posted by StMarc , Jul 11, 2008 3:30PM
Good point. Basically, if you hold a currency or negotiable instruments of any kind denominated in that currency, inflating the supply of it is the indirect tax of which I spoke. It's actually good for holders of real assets which have to be bought with the inflated currency, at least until then they try to hold or spend it in turn. In the end, though, everybody who buys things with the currency eventually pays the tax if the inflation continues.
Another way to think of it is that monetary inflation is a tax on savers for the benefit of borrowers. We have way more borrowers than savers in the US. Therefore since both their votes count the same it is inevitable that over time policy will come to favor monetary inflation.
M
Posted by guest , Jul 11, 2008 3:44PM
Controlling inflation is easier for a central bank that controlling deflation is. Of course, controlling inflation comes at a cost but still, it is something that can be done. Deflation is a whole other beast.
Which is why most central bankers will always tend to err on the side of an inflationary monetary policy - till it gets a little too high when they need to assauge popular discontent.
Posted by StMarc , Jul 11, 2008 3:52PM
Why would you *want* to control deflation?
Price deflation is what you get when an economy is productive and getting more productive. The only way to get monetary deflation is to not print new bills as the old ones wear out. Obviously the latter could be an inconvenience, but nowadays it seems like they could do some statistics and figure out how many bills get worn out or lost in freak blizzards or whatever. And the former is what the Industrial/Green/Information/Etc Revolutions were supposed to be all about.
Okay, kidding aside, obviously deflation is bad news for producers. But lower real prices carry their own cure, and unlike higher real prices it's not likely to be all that catastrophic. Japan had deflation for umpteen years and it doesn't seem like they had to fall back on bread lines or anything. Compare and contrast inflationary recessions/depressions.
M
Posted by guest , Jul 11, 2008 4:01PM
Not necessarily. Deflation can bring the economy to grinding halt. It is not about lower real prices - it is about know that your money will be worth more in the future than they are now. When that thought sets in - people will completely halt spending / consumption. That is the opposite of an inflationary state where knowing that your money will be worth less in the future you would look to immediately spend it.
Depressions are primarily deflationary, not inflationary. Which is why central bankers avoid it like plague. Plus you can kill inflation with very high interest rates. You can go no lower tha 0 to kill deflation.
Posted by Anal_yst , Jul 11, 2008 4:16PM
I'm glad to see that reason seems to favor my point (or something close to it), now if only the rest of the financial press would pull their heads out of their asses, sigh...
Posted by StMarc , Jul 11, 2008 4:49PM
Sure you can go below zero interest rates. You can say, "Here's a thousand dollars. Tomorrow I want nine hundred back." While this seems preposterous it's in essence what's happening now - you can borrow money below the official inflation rate. That's free purchasing power - a yen carry trade without the yen! (Speaking of yen, ISTR that the BOJ actually *did* lend at a negative rate for a short period.)
Hell, if you go by pre-hedonic inflation measures you can borrow money at unbelievable positive spreads. Of course you still have to find something to buy that you can liquidate for a currency profit, but no plan is perfect. :)
Deflation does not cause depressions. Uncertainty causes depressions. (Well, mostly gigantic financial crises cause depressions. But uncertainty makes them last.) Sure deflation causes lower spending on a deflating commodity, but people are, by and large, spendthrifts, and will simply spend more on something else. They refrain from this not when they fear a better deal tomorrow, but when they fear NO deal tomorrow - i.e. that lower prices won't help them because they won't have any income.
M
Posted by guest , Jul 11, 2008 7:30PM
From what I have read, deflation in Japan resulted in the Japanese spending less on consumer goods. Culturally, there is a savings mentality, and when the Japanese see prices fall, they have no incentive to buy, because they think things will be cheaper tomorrow. Because they have been doing well for years, there's not much stuff people actually need.