Critique by Bob Eisenbeis
A recent column by Allan Sloan and Doris Burke in The Washington Post claims that the distasteful financial bailout not only worked but also generated a profit for the government of at least $40 billion and perhaps as much as $100 billion. Their conclusion is based on their working of the numbers, and the source of the so-called “profit” is the interest that the Fed has earned on the assets acquired through QE1 and QE2 and returned to the Treasury. They estimate that a net $102 billion has been returned to the Treasury by the Fed in 2010 and indicate that as much as $85 billion more may be returned this year.
Unfortunately, the authors have played fast and loose with the numbers. They have ignored important unreported costs of the bailout and, most importantly, they have misrepresented the true nature of Federal Reserve transfers of earnings to the Treasury. Because of these problems, their analysis risks becoming part of revisionist history that obscures the true costs of the bailout to the taxpayer. Their work is already being cited in the hearings on FOMC monetary policy of July 13, 2011. Let us try to put forth a more objective take on the numbers and the kinds of analysis that must be done to get a clearer picture of the true costs of the bailout.
Consider first the authors’ treatment of the costs associated with Freddie and Fannie, which they state is the source of the biggest costs of the bailout. They pull numbers from a CBO June 2, 2011, report stating that the government has injected $130 billion on net into those institutions. But this ignores other important costs also contained in that same CBO report. Specifically, the CBO states that fair-market adjustments to the assets and liabilities of Freddie and Fannie expose another $187 billion in unrecognized losses that must be added to the expected costs of their failure. Additionally, the CBO also estimates that the value of projected government subsidies to Freddie and Fannie between 2012 and 2021 will add another $42 billion to the estimated costs, bringing the likely total to $359 billion. This is far in excess of the $130 billion put forward by the authors and is sufficient to generate a significant “loss” on the bailout. But there is more.
I don’t quibble with some of the other estimates except to note that the low-interest-rate environment that the Federal Reserve has engineered has been a clear subsidy to financial institutions. The value of that subsidy should be considered a cost, but doesn’t appear in anybody’s calculations. Then there is the value of the subsidized support provided through the discount window and other Fed emergency programs. Nor do people consider the fact that institutions have been able to borrow in the Federal Funds market at a rate substantially below the 25-basis-point risk-free rate that can be earned by depositing those funds at the Federal Reserve. Banks are also receiving 25 basis points, risk free, on excess reserves held in deposit accounts at the Federal Reserve.
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