Thursday, January 27, 2011

Bank Subsidies as Crisis Response

Via WSJ's Real Time Economics I read this from Economics Professor Axel Leijonhufvud on the response to the financial crisis and our current monetary policy:
  • The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.
  • This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress....
  • The bailouts of the banks during the crisis were clear for all to see and caused widespread outrage; now the public is being told that they are being repaid at no cost to the taxpayer.
  • What the public is not told is that the repayments come to a substantial extent out of revenues paid by taxpayers for the banks to hold Treasuries.
  • Both parties supported the bailouts so neither party seems ready to protest the claim that they are being repaid at no cost to taxpayers.
Even (especially!) if you don't want to hear any more about TARP, the crisis, or monetary policy, I urge you to read the whole short post. It is completely at odds with the official line from Obama, Geithner, & Bernanke (Bush & Paulson as well) and shines a light on a dark side of the response.

Whatever the causes of the financial crisis, I firmly believe that much of our response, whether consciously or not, has been to save financial institutions from their own mismanagement. Regardless of the final balance in the TARP fund, this won't be a zero cost proposition.

In Paul Ryan's State of the Union response, he warned of turning the social safety net into a hammock, where we could fall asleep. Unfortunately, we may have already turned our monetary policy into the proverbial golden parachute, rewarding the very folks who failed so spectacularly leading up to the crisis. This includes not only the managers of large firms, but their boards, shareholders, the media, and especially their creditors.

The argument is that such a parachute was necessary since these firms were in free fall and rather than staying in the plane at 10,000 ft., we were tethered to them as they plummeted to earth. Fine, then we'll all hold our noses and pull the rip cord. But once we are safely back on the ground we need to gather up our golden parachute (tattered and torn as it may be) and leave these guys standing on the tarmac.

Our current policy seems aimed more toward letting these guys fashion a comfortable bed from the chute while too many average Americans suffer through a hard landing largely not of their own making.


Dad29 said...

And there's another risk: if T-bond rates rise, the value of the banks' bond portfolio falls.

Yes, the Fed can continue purchase of T-bonds for a while; but the vigilantes are out there, too, waiting....

Dean said...

So what keeps savers rates low and bond rates higher if the market is competative? Shouldn't these rates converge?

What does Axel want? Does he want the Fed to increase rates? What is his solution and will it help or hurt?

Jeremy R. Shown said...


Deposits are short term lending and they typically will have different rates than long term. Over time these won't converge. Long term rates are normally expected to increase as the time to repayment gets longer. That is to say, lenders will charge more the longer you want to hold their money.

As far as this post goes, I think the professor was just trying to spread the word more than anything. The post is short, non-technical and to the point. He seems a bit incensed that neither party is facing up to the reality of the response and a bit sad that people can't see what he sees.

Dean said...

Thanks for the reply Jeremy. My take on this so far is that Axel is being disingenious if this differetial between short and long term is really normal. He is complaining about a problem that does not really exist. Long term is more risky thus pays more.

Don't get me wrong, I worry about subsudies to bankers, but this does not appear to be it.

Anonymous said...

Here's all you need to know.