Meet the Hazzards
As we mark the end of the first year of the financial bailout, the public seems to regard the government's actions with a toxic combination of rage and confusion. People are pissed off but too bewildered to know what to do with that anger. The confusion isn't an accident. The government hasn't exactly been forthcoming about how it's made buckets of money available to the banking sector. When it does disclose some information--such as in July's SIGTARP report from the Treasury or the Federal Reserve's weekly balance sheet--it's in the form of intimidating descriptions, accounting mumbo jumbo and technical reports that do little to illuminate just what the hell is going on.
What's worse, banks and the establishment press have portrayed TARP as the sum of the banking industry's federal subsidies. An August 30 New York Times article, "As Banks Repay Bailout Money, U.S. Sees a Profit," gives the impression that taxpayers should be happy to have made $4 billion on the deal, as if our checks were in the mail. But when the government became Wall Street's bank, it wasn't just $700 billion of TARP money that flew north to Wall Street. TARP was but a small fraction (roughly 4 percent) of the full $17.5 trillion bailout and subsidization of the financial sector. [See image.] The details of this total bailout are complicated, but the basic mechanisms aren't beyond the average citizen's grasp. We're going to walk you through it.
Five Easy Pieces: The Tale of Joe and Katie
There are five ways the Treasury, the Fed and other government entities have propped up the banking sector. In order to understand how each of these works, let's consider how this assistance might have looked had it been directed at a household, rather than a bank, teetering on the edge of bankruptcy. The analogy isn't exact, but considering the bailout in this manner helps make the whole thing a lot clearer.
Imagine a couple living in a three-bedroom house outside the Twin Cities. Call them Joe and Katie Hazzard. The Hazzards own a small off-track-betting (OTB) business and have some investments and a mortgage on their house. But business is terrible (no one has extra money to make bets); Katie recently lost her job; their investments have hemorrhaged value; and they can't make their mortgage, car or credit card payments. So they ask their local bank for a loan. "No dice," says the bank. "We can't give you money to pay your debts because you're no longer a good credit risk for us." That's more or less what happened to the banks last fall: they couldn't and wouldn't lend to one another.
Capital Injections and Direct Loans
So the Hazzards go to the Federal Bailout Bank, which says, "Here's some money. Do with it what you want, and someday down the road, if and when you're out of the woods, you'll have to pay us back with a little bit of interest." That's roughly what the $700 billion TARP was: a direct injection of capital to purchase preferred shares, which is really more like extending a loan than making the investment the government said it was, with some very light strings attached.
But then Joe says that the handout isn't enough. It turns out that not only does he own a gambling business; he has a bit of a gambling habit. Joe made big money in previous years betting on the New England Patriots to win the Super Bowl and figured he couldn't go wrong placing the same wager again. But then Tom Brady injured his knee last year, and Joe got creamed. Inveterate gambler that he is, he's doubled down on the Patriots this year, but he won't be paid off (if, that is, the Patriots win) until later in the year. But Joe has a boatload of outstanding gambling debts he needs to pay now.
So the Federal Bailout Bank decides it'll help out. To cover the truly pressing debts (the bookie is about to send over some goons with baseball bats), the bank will just write a check. That's what the Fed did to back the losses of AIG's credit default swaps and other businesses, and what the Fed and Treasury did together by providing protection to Citigroup in the event that more of its toxic assets lost value. The money--$1.4 trillion--was structured as a loan, but it's a bit unclear how it will ever be paid back.
In addition to his bets on the Patriots, it turns out, Joe's been making bets on just about anything, the outcomes of which have yet to be determined. The Hazzards are scared that a lot of these bets don't look too promising (e.g., Joe's wager that Kanye West will win this year's Nobel Peace Prize). What they want is to unload their positions in those bets, to have some other gambler pay them the original sum they put down and take on the risk. If the bet makes good, the new gambler would get the rewards. If it doesn't, he would take the loss. But they can't find anyone to do that because so many of Joe's wagers were so reckless.
Once again, the Bailout Bank steps in to sweeten the deal, telling would-be gamblers it will put in $6 for every $1 they put up. That means Joe's Kanye West bet for $100 (at very long odds) can now be purchased by a fellow gambler for just $14.28. If Kanye does, in fact, win the Nobel, then this lucky gambler will get paid as if he had put up the whole $100. If not, he's only out fourteen bucks. That's the crux of Tim Geithner's $1 trillion Public-Private Investment Fund, which would bring the full amount of capital injections and direct loans to $2.4 trillion.
Indirect Loans and Guarantees
The Hazzards come back and claim that wasn't enough; they're still screwed. So the bank says, "We can give you some more short-term, thirty-day loans to get you through (even longer-term ones if that doesn't work), but you have to post collateral. It doesn't have to be very valuable: your old bicycles in the garage, your basement sofa-bed, maybe that baseball card collection you planned to use to pay for your kids' college educations. And if you still need more at the end of the thirty days, you can post some more junk from your attic as collateral."
This more or less corresponds to the newly established Federal Reserve facilities (think: credit unions for banks), which provide money to banks in exchange for various assets as collateral. Both the Federal Reserve and the Federal Reserve Bank of New York administer these facilities. They run the gamut from the $1.8 trillion Commercial Paper Funding Facility, created to provide more credit for households and businesses (which, to be fair, did help calm the markets; but it didn't get to households or to most small businesses), to the $540 billion Money Market Investor Funding Facility, created to back private funds owned by banks, insurance companies or investment advisory companies.
Joe comes back again to Bailout Bank and says that he's still short, but he has a proposal. "I'm not going to ask you for any more loans. Promise. Instead, I'm going to see if someone else will lend me money. The problem is, I'm such a terrible credit risk I need someone to back me up. Maybe instead of me asking for a loan, I could kind of use your name to ask?" That's the role the FDIC played for Goldman Sachs and other firms, which took advantage of $940 billion in FDIC guarantees to raise cheap money for themselves and another $684 billion of backing for their trading accounts as an additional perk.
All in all, these kinds of guarantees, along with the indirect collateral loans for the banking industry, total $6.7 trillion, and there is precious little transparency coming from the Fed regarding most of it. In fact, Ben Bernanke told Congress in November that too much transparency about which banks got which loans and for what collateral would be "counterproductive."
General Backing and Subsidization
Bailout Bank isn't done helping the Hazzards. It turns out that the couple also has a vacation condo that's lost some value. As part of propping up their balance sheet, the Bailout Bank promises to guarantee the price of the condo. In other words, if Joe and Katie are forced to sell the condo for less than its value before the housing crisis, the Bailout Bank will write them a check for the difference in price.
This is considered "general backing," and in the bailout economy it applies to all kinds of things that weren't supposed to lose value but did and might continue to do so in the future--most important, money market funds. About $4.4 trillion was set aside for general backing of financial firms, including $3.7 trillion to mitigate any future problems with money market funds and an extra $700 billion for the FDIC to continue to back depositor funds. (The banks didn't want to pony up more premiums to do it themselves. Can you imagine just deciding you don't want to pay your insurance premiums, yet receiving insurance anyway? Well, it's like that.)
Government-Sponsored Entities Help
Another part of what's putting the hurt on the Hazzards is the plummeting value of their big investment in what had been the rock-solid, blue-chip ABC Corp. This was supposed to be one of their safest investments, but now they can't sell the stock without taking a massive loss. So the Bailout Bank steps in. It starts buying tons of ABC stock, flooding it with capital and creating an inflated price for the stock in the process. This in turn raises the value of the Hazzards' investment. Bailout Bank even goes so far as to start buying ABC's products, hoping to increase its sales and thus its stock price.
Though a bit imprecise, this is basically how the Fed and Treasury propped up Fannie Mae and Freddie Mac and in the process helped the banks. The Treasury bought Fannie and Freddie stock and also the mortgages that the two enterprises sell, plus it gave them some extra money to lend. All the government's financial assistance to prop up entities that were considered safe at one point comes to $2.2 trillion.
Global Market and Credit Expansions
Finally, just to make sure the Hazzards can get by, the Bailout Bank decides to help everyone who might use their business with some capital of their own. Since the couple runs an OTB business, when the bank gives a shot of money to everyone in town, a few people start gambling with the Hazzards again. In effect, that's what the Fed did when it dumped $905 billion into international markets to move things along and another $881 billion into domestic ones. Throwing cash here and there into the markets is the Fed's job; throwing the amounts it did was an act of desperation, although almost certainly needed.
It's important to remember that not everything the government did was solely bank-friendly. The Fed and Treasury extended $1.82 trillion in fiscal support, including about $1 trillion in direct consumer assistance (including the Recovery Act, the Cash for Clunkers program and first-time homebuyer tax breaks). It gave another $881 billion to help guarantee various federal home mortgage programs, which really did help homeowners. But this help is dwarfed by the mountains of dollars thrown at Wall Street [See image.]
Our Joe and Katie Hazzard parable is inexact. Not every bank took advantage of every kind of assistance (though some, like Citigroup, pretty much did). And households aren't structured like banks; they don't lend money or borrow big to bet big. But that's why cheap credit is a much bigger boon to banks than to households. Borrowing at a lower rate than they lend is how banks make money. Getting to borrow for next to nothing almost guarantees massive profits.
The Hazzards' tale does illuminate a few key aspects of the bailout that tend to be obscured by acronyms and decimal places. It shows the extraordinary measures the government took to prop up the banks and the financial system. It's not just one mechanism, one check or one loan. It's concentric circles of support, from "Here's some money to cover your losses" (AIG) to "We're gonna make sure there's money flowing through all the neighborhoods near you so you keep having customers" (international assistance).
It also shows how hard it is to answer the question, How much did it all cost? The amount of money that's been floated, injected and dispersed in the ways we've listed above is $17.5 trillion. But what the final cost will be is not yet clear. A lot depends on how the Hazzards do. They might pay back a lot of the loans (perhaps even with interest) and not use up the guarantees. Their condo may rise in value, or they might have to sell it at a loss and rely on the Bailout Bank's price guarantee. The baseball card collection taken as collateral may end up in the bank's hands, and then the total loss will depend on what the card collection turns out to be worth. In short, while we can add up the total exposure of the bailouts, we can't yet tally their cost.
Finally, our tale shows how fully the banking industry has relied on the government to keep it afloat. This is a crucial point because many banks want to argue that once they've paid back their TARP money, they have discharged their obligations and are private entities again, unbeholden in any way to taxpayers.
Another question our parable doesn't answer is, Where does all the money come from? Most of it has been "printed" by the Fed, which expanded its balance sheet and, in so doing, created money out of thin air. There's nothing wrong with printing money for the sake of keeping us from another Great Depression. In fact, not taking this step would have been disastrous. But the problem is how the money has been channeled. All that money was funneled through the banks; the real Joe and Katies--the actual households facing foreclosure and declining assets--haven't gotten much help. In fact, foreclosures are at an all-time high (7.5 million US homes are in foreclosure), and there have been 1.25 million personal bankruptcies this year through June (up 34 percent from last year). Unemployment continues to climb. The FDIC continues to take over failing banks. Credit has tightened, not loosened as all the pre-bailout rhetoric promised.
A fraction of the $17.5 trillion bailout could have been used to cut the principal of homeowners' mortgages (using homes, even devalued ones, as collateral) and cover student loans at zero percent interest. Rather than pouring it into the top layers--the banks--a people's bailout would have cost less and been more humane. And it likely would have prevented the ongoing increase in defaults, foreclosures and general economic anxiety.
The banks would have hated that, of course. Even in their degraded state they have a lot of friends in Washington. Imagine if the Hazzards started using some of their easy money to hire lobbyists to make sure the Bailout Bank maintained its pro-Hazzard policies. Because that's what's going on. Banks are lobbying Congress very hard to maintain their setup. Just one year after the crisis, boasting record profits and on track for record bonuses, they are darkly warning that any new regulation could hamper growth.
Given the banks' newfound publicly sponsored financial health, Washington has little incentive to rock the boat by proposing serious reforms. True, some necessary steps are being discussed by Congress: it's important to have a Consumer Financial Protection Agency to counteract the damage caused by lax oversight, and higher capital requirements so that banks can pay for their own risk fallout. But the Fed should not be the premier risk regulator, nor should we believe that it will cap extreme bonuses--President Obama doesn't even support a cap. Parts of the media are already reporting the end of the recession; Obama has moved to reappoint Bernanke, crediting him with keeping the country from a Great Depression, and has given tacit approval to the free flow of bank subsidies. The Treasury, headed by the man who was at the helm of the New York Fed when it nearly went down, is no less culpable for bad decisions.
Such lack of accountability seems to be something of a theme. Despite conducting themselves recklessly, compulsively, almost sociopathically, our fictional Joe and Katie Hazzard got a lot of money to help maintain their lifestyle and assets. But what happens when they take all that money and double down on the wrong bet? Will they be back for another helping? Why wouldn't they be? Given everything our government has said and done so far, and the meager reform ideas on the table, it's very likely there will be another bad bet coming from the entire industry--and with it, the vaporizing of much of the assistance doled out to avoid that very occurrence.