Bad Math and Bad Analysis
July 13, 2011
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 QE 1 and QE 2 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 (http://www.cbo.gov/ftpdocs/122xx/doc12213/06-02-GSEs_Testimony.pdf) 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 2012-2021 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.
The real problem with the Sloan-Burke analysis, however, is in their treatment of the Federal Reserve’s excess revenues over costs that are transferred to the Treasury. They suggest that the assets purchased as part of QE 1 and QE 2 have generated additional “profits” of about $102 billion for 2010 and another estimated $55 billion for 2011.
As we have noted in previous commentaries, the peculiarities of government accounting conventions treat these transfers as revenue to the Treasury. Thus, the funds can also be counted towards reducing the deficit. Treating an interest expense as revenue when returned by the Fed to the Treasury is really an accounting shell game. Consider what the Fed has done. It has printed money by issuing one form of government debt, to purchase to purchase other forms of government debt, Treasuries and MBS from government-backed Freddie and Fannie. The government (Treasury) pays interest to another government entity (Federal Reserve) on those assets, and when the funds are transferred back to the Treasury an expense is magically transformed into revenue.
If the Fed purchased those securities directly from the Treasury, which it is legally prohibited from doing, the Fed would be directly monetizing the debt. It is now indirectly monetizing the debt. The revenues from this activity are not profits, nor should they be considered a return on investment from the bailout. Rather they are simply an intergovernmental transfer that results from printing money.
If it were that easy to reduce the deficit, then the Fed could simply buy up as much debt as possible. The Treasury could then use the return of interest payments it makes to the Fed to reduce the deficit to zero. If a little works, then why not do a lot? It is like writing a check to your wife, and when she gifts it back, you count it as income. The process makes Bernie Madoff’s Ponzi scheme look like chump change.
Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. He may be reached at Bob.Eisenbeis-at-cumber.com.