Sunday, October 04, 2009

5 Ways the Government Used Our Money to Save Big Banks and Screw Us

By Nomi Prins and Christopher Hayes, The Nation. Posted September 26, 2009.

The government hasn't exactly been forthcoming about how it has made buckets of money available to the banking sector. But here's what really happened.

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More stories by Nomi Prins Christopher Hayes

    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. 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.

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See more stories tagged with: banks, money, bailout

Nomi Prins is a senior fellow at the public policy center Demos and author of It Takes a Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from Washington to Wall Street.

Christopher Hayes is The Nation's Washington editor.

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