A column in Saturday’s Washington Post entitled “Bailout Highly Profitable for Taxpayers, When You Look at the Right Numbers,” argues that the government financial bailout was a windfall to taxpayers. However, the analysis is wrong – and fails to look at the right numbers.
Let us consider both the analysis and numbers starting with the biggest problems first. The largest portion ($474 billion) of the supposed taxpayer gain results from remittances from the Federal Reserve to the Treasury, which the column improperly views as profits. The analysis fails to consider that the proper way to treat the Federal Reserve’s balance sheet, for purposes of evaluating the cost of the financial crisis, is as part of the consolidated federal balance sheet and not as a private entity. The Fed bought Treasury obligations in the market by creating short-duration reserve deposits; the Treasury makes interest payments to the Fed; the Fed takes out its operating costs and returns the difference to the Treasury after paying the statutory 6% dividend to member banks and making any additions to its capital account.
While the Federal Reserve Banks are quasi-public entities created by Congress, the Board of Governors is a federal government agency; and, more importantly, Federal Reserve debt is guaranteed by the government. The Fed is part of the government and should be viewed as such, at least when considering intra-governmental fund flows between the Treasury and Fed. Fed asset purchases simply substitute one form of government debt (reserve deposits) held by the public for another form (Treasury bills and notes). In terms of intra-governmental fund flows, Treasury interest payments simply advance money to the Fed, which covers the Fed’s operating costs and in turn, the Fed returns the difference to the Treasury. If those two transactions were netted the way interest rate swaps are settled, there would always be a net flow of funds from the Treasury to the Fed. In short, viewed properly, the Fed can never make a profit on such transactions as the Washington Post column claims, and it is totally wrong to include Fed remittances as a profit to the taxpayers. Put in its simplest terms, if my wife writes me a check for $100, and I spend $10 on gas and give the rest back to her, we as a family are not $90 richer. We have simply spent $10. This is the kind of phony accounting that the Washington Post column tries to convince us applies to Fed remittances and creates benefits to taxpayers.
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There are other problems with the computations that go far beyond a simplistic adding up of cash flows. Specifically, an objective analysis would also include as a cost to taxpayers the value of the implicit subsidy that the government conveyed to the supported institutions in terms of lower borrowing and equity costs. All of that value was transferred to shareholders and management and was not shared with taxpayers. It should properly be viewed as a taxpayer cost. Professor Edward Kane (Boston College), who is a member of the Shadow Financial Regulatory Committee, has written extensively and offered Congressional testimony on this very point as to the proper way to value the cost of the bailout and the subsidies that too-big-to-fail institutions received from the taxpayer’s perspective.
As for Freddie and Fannie, these institutions were created as government sponsored entities, always regarded by markets as implicitly guaranteed by the government and seen as too-big-to-fail. When we attempt to calculate the true costs of the gambles Freddie and Fannie took – gambles that necessitated their takeover by the government – if we fail, as the writer of the Washington Post column does, to consider the value of those implicit guarantees that historically accrued to shareholders and debt holders in the form of lower debt and equity costs, then we seriously understate the financial position of taxpayers. When analyzed properly, the bailout’s impact on the taxpayers looks nothing like the rosy scenario painted in the Washington Post column.
