Banks, TARP, Treasuries

This week, we find out that 10 banks are returning TARP money. Or more specifically, 10 banks are repaying $68.3 billion in federal bailout money. This does not mean that these banks are freeing themselves from the yoke of government (only, says the snark in me, it allows them to pay themselves obscene amounts of money to retain the best and the brightest. Best and the brightest. Just keep clapping!).

On the contrary, their ability to bring in profits over the past quarter are almost certainly the result of near-zero federal funds rates and an alphabet soup of government support programs.

The FDIC has been providing a Temporary Liquidity Guarantee Program (.pdf) since November 2008 (guaranteeing unsecured senior debt of eligible banks); the Federal Reserve’s Commercial Paper Funding Facility (CPFF) purchases three-month unsecured and asset-backed commercial paper from banking institutions; the Fed’s Asset Backed Commercial Paper (ABCP) Money Market Mutual Fund (MMMF) Liquidity Facility and the Money Market Investor Funding Facility (MMIFF) buy asset-backed debt to support money market funds; the Fed’s Term Asset-Backed Securities Loan Facility (TALF) supports “the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).”

There are two effects here, one practical and one theoretical. The practical effect is to make money cheap and relatively risk-free, or at least to transfer the risk to the federal government and the profits to the private sector. So think about what this means, not for the 10 banks whose free money is putting them above the ‘stress test’ line, but the rest of the banks (Citi!!!) whose free money isn’t.

The second effect, which is more interesting from the point of view of economic sociology, is that the federal guarantee of almost any risky asset held by a private financial institution effectively alters the information contained in the market price of these institutions and assets. I would almost but not quite suggest that the state has effectively transformed the toxic assets held by banks into US Treasury bonds, but it’s not not doing that.

More specifically, you might ask: what the price of an asset is that is guaranteed by the federal government? How valuable is it? How much risk does it embody? These questions are unanswerable, and in this sense, the alphabet soup of programs and supports have significantly reduced the signal-to-noise ratio of credit market prices. This is a momentous shift in the financial system.

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