The $29 Trillion Bail-Out: A Resolution and Conclusion

I have argued that if we want to get a measure of the size of the Fed’s bail-out, we ought to add up the lending and asset purchases undertaken over the past three years through its alphabet soup of special emergency facilities.

This is what my students Nicola Matthews and James Felkerson have done, and you can read the first working paper reporting those results over at www.levy.org. The total is $29 trillion, much bigger than estimates by Bloomberg, but actually in line with the GAO’s estimate of $16 trillion that excluded the “liquidity swaps” with foreign central banks. As that was about $10 trillion, our number is in the same ball-park.

In our work, we also report and discuss the usefulness of the Fed’s approach—which is to report the maximum peak outstanding quantity of loans—about $1.2 trillion on a day in December 2008. While that is a good measure of maximum exposure to risk, clearly it is a snapshot and doesn’t tell us much about the total effort that has continued right up to the present. It is conceivable that the Fed’s total intervention could have been for a few days in December of 2008—in which case the peak loans outstanding and the cumulative total of lending would have been close to the same size. Clearly that was not the case—the cumulative total is 25 times bigger than the peak. Why? Because the Fed’s intervention continued for months and even years. It continued to lend at very low rates and very large volumes to try to settle markets. The cumulative total is a more informative measure.

After my blogs and the release of Felkerson’s working paper at Levy we got a lot of expected push-back by market insiders and economists with strong links to the Fed. For example, James Hamilton (who admits to working for the Fed for the past 20 years—one of the many economists around the country who are in the Fed’s stable of economists whose research is regularly funded) criticized us here on Economonitor as follows:

Felkerson takes the gross new lending under the Term Auction Facility each week from 2007 to 2010 and adds these numbers together to arrive at a cumulative total that comes to $3.8 trillion. To make the number sound big, of course you want to count only the money 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 week over this period– that is, subtract each week’s loan repayment from that week’s new loan issue– and add those net loan amounts together across all weeks, you would arrive at a cumulative total that equals exactly zero. The number is zero because every loan was repaid, and there are no loans currently outstanding under this program. But zero isn’t quite as fun a number with which to try to rouse the rabble.

Note the characterization of Fed critics as “rabble”. Hamilton and Fed-funded insiders try very hard to claim that anyone who would criticize the Fed’s bailout is incompetent, unable to tell the difference between a stock and a flow. In fact, both my original blog as well as the Felkerson working paper are careful to make the distinction. It is clear that Hamilton’s critique is nothing more than flack. This is the kind of flack that the Fed’s defenders always throw out, hoping that no one will read beyond the defense if they can flood the discussion with erroneous accusations. If anyone actually read what we wrote, they would easily see that Hamilton’s response is nothing more than a baseless hack job.

His use of the word “rabble” to describe me and fellow critics is yet another example of the way the top 1% and its sycophants look at the rest of us—the 99%. Hamilton’s statement reminds me of a talk my colleague Bill Black gave the other day at UMKC on Citigroup’s infamous “Plutonomy Memo” to its richest clients, celebrating the rising inequality of US society. It’s really nice to get a window on the way that Hamilton views us– “rabble” 99 percenters. Personally, I like the label—I’m inclined to wear it.

Also note how silly Hamilton’s argument is: net lending is zero on loans that are rolled-over, hence we must logically conclude that the Fed actually lent nothing, did not bail-out financial institutions, and that Wall Street resolved its problems with no help from the Fed. He actually sent his critique to me and invited comment. I did write a short comment, along those lines. I guess he was not pleased as he did not publish it.

Another critic who does not use his/her real name but uses the handle “Alea” sticks very close to talking points:

You (and your students) still don’t get the difference between “Term Adjusted” and “Not Term Adjusted”. On a “Not Term Adjusted” basis (the way GAO gets $ 16 trillion and $26 trillion with swaps) a bank borrowing $1 bln for a one year term 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 back at 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 liquidity shortage 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 or two. But the Fed is NOT supposed to lend for a year! This is emergency lending, after all, provided in what the Fed admits were extraordinary facilities created specifically because of the crisis. Lending and asset purchases were supposed to be temporary and expensive.

But in fact, the Fed lent “overnight” on a chronic basis to our liquidity chugging banks because they could not fund themselves 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 overnight lender-of-last-resort facilities it does make sense to add up across the loans.

That is a far better measure of the extent of the Fed’s efforts to bail out troubled banks—who should be expected to fund themselves in markets, not at the lender-of-last-resort!

Indeed, we asked a retired Fed official what he thought of all this extended Fed intervention into markets—just in case we were off-base. His response was as follows:

The Fed has traditionally made a distinction between “continuous borrowing” and borrowing in emergencies which it terms “exigent borrowing.” The distinction depends on the cause for borrowing.

Continuous borrowing, in the Fed’s view, does not so much suggest “weakness” in the borrower as it does profit-making – borrowing at a relatively low rate of interest to invest at a higher rate. When the Federal Reserve was first organized, there were no limits on the duration or amount of borrowing at the discount window. As long as banks had acceptable bills to discount, or securities to use as collateral, they could borrow indefinitely. When, the Fed began to use open market operations, it realized that it would have to control the amount of credit flowing through the discount window to make its operations effective. Its rules restricting “continuous borrowing” were formulated to do this. (Note that exceptions have developed over the last 40 years, and I believe it has tried to rely more on rate changes to control borrowing, and less on non-price rationing).

At the same time, a principal purpose of the discount window has been to provide assistance to banks in distress that were short of liquid funds to meet demands – whether the distress was the result of a natural disaster; e.g., a hurricane or earthquake, or a financial crisis. Borrowing in exigent circumstances could be for relatively long periods of time.

The Fed’s “liquidity provisioning” in the recent crisis has been different than in the past in a number of respects –in the securities it has accepted as collateral – mortgage-backed securities; and in the financial companies to which it made loans – some of which were likely insolvent, at least, short of government investment, and some that only became bank holding companies in order to obtain Federal Reserve credit. This was “liquidity provisioning,” on steroids.”

Liquidity provisioning on steroids. Exactly. $29 trillion worth. And it certainly looks like the purpose was to provide continuous access to low cost funding.

I also asked a banker, who responded this way:

I was buying short term securities that 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 CMBS securities at the Fed. I could have used FDIC insured deposits but the Fed was a tad cheaper. Banks use the cheapest funding available.”

To translate that: banks could have funded commercial mortgage backed securities with certificates of deposit insured by the FDIC, or by borrowing using the Fed’s special facilities. The banker confirmed what both Bloomberg and Senator Sanders argued: the Fed’s special facilities gave banks the cheapest funding available. And the Fed very nicely extended the cheapest funding to the Real Housewives 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.

$29 trillion, mostly secret, unprecedented, and unwarranted bail-out. That’s what it was.

And get ready. The financial system is going to collapse again. Fed might need a bigger bazooka.