Fed Profits And Treasury Financing: The Good And The Bad

Includes: DIA, QQQ, SPY
by: Bob McTeer

We learned Thursday that the Federal Reserves turned over $89 billion of its profits, primarily from interest on its securities portfolio, to the U.S. Treasury during 2012. The amount repatriated in recent years has grown substantially because of the sharp growth in the Fed’s total assets resulting from its purchases of Treasuries and Mortgage-Backed Securities. This has substantially eased the burden on taxpayers of financing the budget deficit. So have the low borrowing rates the Treasury has enjoyed in recent years, thanks, in large part, to the Fed’s efforts to push rates down to stimulate economic activity.

When I saw the press reports on this Thursday, it reminded me of the Q&A following a speech I made Wednesday. As has happened numerous times before, a member of the audience was distraught over the pain that will be caused when interest rates eventually rise and increase the cost of financing our debt. That is a valid worry, but what strikes me is that people love to worry about when the good thing (in a limited sense admittedly) comes to an end without being appreciative of the good thing while it lasts.

Another comment from the audience had to do with the pain caused to savers by the low interest rate environment. I agreed and pointed out that periods of easy money designed to pull us out of recession always have losers as well as winners, but, in the past, the losers have been ignored because the lower rates were considered temporary and were considered for the greater good. I then acknowledged that low rates this time around have lasted four years and counting - quite a different matter. I mentioned my latest posts in which I argued for the FOMC allowing interest rates to rise a bit within a broader context of continued monetary ease on the quantity side. I had a chance to pander and took it.

What I didn’t point out - and probably should have - is that while monetary policy has wiped out the return on our savings accounts and CDs at banks, it has also supported the stock market as well as the broader economy. We all like to complain about the low interest-rate pain caused by the Fed but don’t make any connection to the recent recovery in our IRA and 401(k) balances and other equity investments. I sense that my audiences get grumpy when I defend the Fed, so I often hold back on my defense.

Not too long ago, it seemed like the entire population was incensed that TARP used taxpayer funds to “bail out” the banking system, as if we would all be better off if our banking system collapsed. Once I started mentioning that the TARP money spent to buy preferred stock in banks was turning a profit for the taxpayer, nobody wanted to hear it. I even tried for a while - and failed - to discuss rationally the meaning of “bailout” of institutions whose stockholders lost the total value of their holdings and management and directors lost their jobs and reputations. I thought making that point would be helpful in discussing more rationally the concept of moral hazard.

The simplistic view of moral hazard was that ailing institutions must be allowed to die without help, or even put down, lest others follow down the same path. It made no difference that perfectly sound institutions (mainly banks) in normal times could lose their liquidity in a general panic situation that was no fault of their own. But, beyond that, failure and humiliation is not something that others would want to emulate. A so-called “bailout” was nothing to be desired and incorporated into the planning process. Needless to say, neither of these arguments or considerations made a dint in peoples’ resolve not to “accentuate the positive and eliminate the negative.” I never got anywhere “latching onto the affirmative.”

Ironically, we don’t hear as much negative commentary as we used to about the extraordinary policy measures taken to deal with our financial crisis, recession, and slow recovery. Why not? What happened? What happened was Europe’s more recent financial crisis. Without acknowledging that our policymakers may have known what they were doing after all, we started hearing the talking heads wonder on financial TV why European policymakers couldn’t get their act together.

Why was the European Central Bank not doing what was obviously necessary? What they meant without saying so in so many words was why do the European policymakers not follow the obvious example of the U.S. policymakers. Then a funny thing happened in Europe. The head of the ECB finally said he would do whatever was necessary to save the euro. They still have their problems, but the European crisis immediately dropped off our front pages when Mario Draghi took a page from Ben Bernanke’s handbook.