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November 27, 2011

Congress's $700 Billion TARP Bailout Was a Sideshow

Bloomberg recently won a lawsuit against Wall Street and the Federal Reserve to force the Fed to reveal how many trillions of dollars they handed out to banks and on what terms. All of Bloomberg's giant new article about what they found out is worth reading. But I was particularly struck by this section:

TARP and the Fed lending programs went “hand in hand,” says Sherrill Shaffer, a banking professor at the University of Wyoming in Laramie and a former chief economist at the New York Fed. While the TARP money helped insulate the central bank from losses, the Fed’s willingness to supply seemingly unlimited financing to the banks assured they wouldn’t collapse, protecting the Treasury’s TARP investments, he says.

“Even though the Treasury was in the headlines, the Fed was really behind the scenes engineering it,” Shaffer says.

Since this is what I wrote in June, 2009, I've reposted it below. The Federal Reserve's bailout of Wall Street is what mattered; TARP was a sideshow created to distract everyone from what the Fed was up to.

Note that the media fell for the scam I describe completely. Even This American Life, which has done great journalism about the financial meltdown, produced an episode called "Another Frightening Show About the Economy" on October 3, 2008 that might as well have been dictated by the Federal Reserve (except no one at the Fed has the talent to present it that well). Moreover, to this day essentially no one in the media (except perhaps reporters at Bloomberg) understands what happened.

* * *

Why Did the TARP Bailout Happen the Way It Did?

Here's my answer. It's partly conjecture, but the circumstantial evidence is very strong, and there should be more available with just a little digging.

After the bankruptcy of Lehman and the bailout of AIG in mid-September, Ben Bernanke and Hank Paulson were genuinely worried -- it was now obvious it would require gargantuan amounts of money, starting immediately, to bail out the banking system. Some of the money spent would eventually come back to the government, but inevitably the final losses would be in the hundreds of billions.

BUT -- what worried them was not finding the money. The weird truth is the Fed can literally create money from nothing. That's the way they expand the money supply.

In normal times, the Fed does this by purchasing government bonds. If they want to buy a bond for $100, they just electronically credit the seller, who then has $100 more in their bank account. And the Fed then has the bond in its portfolio. In the past, the total Fed portfolio (almost all government bonds) had been just under $1 trillion.

But in emergencies, the Fed has the legal authority to buy almost anything. As it had demonstrated up to last September, it can buy Citigroup bonds. It can buy $30 billion in crappy mortgage-backed securities from Bear Stearns. It can pay $85 billion for AIG.

So the money wasn't the problem. The problem was that they were going to spend over a trillion dollars, more than doubling the Fed portfolio. Now, if had been possible, the financial industry would have loved it if the Fed could have just taken care of it on its own. That would have been the best possible solution, with no meddling congress members asking questions about executive bonuses.

But $1-2 trillion is so much that even congress and the media would notice. Nancy Pelosi was already complaining about the AIG bailout. And Bernanke and Paulson were well aware that every person in America who didn't work for Goldman Sachs was going to loathe what was coming.

So what did Bernanke, Paulson, and the financial industry need at this point, if not the money?


That's the first rule of political catastrophes: if everyone's guilty, no one can be punished.

This was an opportunity to get everyone else on the hook with them: both parties in congress, and both presidential candidates, each of whom would be under enormous pressure not to look "irresponsible." Even better, getting some TARP money from congress would create a huge distraction from the gigantic amounts of non-TARP money the Fed was shoveling out the door.

So all they had to do now was make congress terrified the economy was about to collapse. And to do this, they needed a plausible story.

This part was tough. After all, if a few banks failed here or there, so what? Depositors were protected, and we were headed into a recession anyway, with a lower need for medium-term credit.

But there was one excellent candidate to be the WMD of the TARP bailout: the commercial paper market.

That's what the Fed, Paulson, and White House were selling to congress and the media. If you go back and look at all the cable news about the bailout, it's obvious "commercial paper" was the talking point. It comes up over and over again. Tom Brokaw, CNN's money reporter, Sen. John Kyl, Mitt Romney -- they all repeated the story like robots. Just like the scary WMD.

It goes like this: big corporations are like rich people with lots of assets and money coming in at irregular intervals but not much cash in the bank. In the same way a rich person like that would use a credit card to buy groceries and gas, big corporations borrow money in the commercial paper market to make payroll, pay vendors, etc. They're continually borrowing money and paying it back the next day or next week.

In normal times, the commercial paper market is extremely boring and extremely safe. But in the same week Lehman went bankrupt and AIG was bailed out, the commercial paper market was collapsing. The pension funds and university endowments that supply the money were spooked, pulling it out, and putting it in government bonds.

This WAS a real, frightening problem. No commercial paper market, and Wal-Mart can't pay for everything being delivered to its stores. Big grocery chains can't pay for food. And no one is paying their workers. The entire economy could grind to a halt, and no one knew how hard it would be to start it again.

But there's one thing Bernanke and Paulson left out, and that all the people talking about on TV didn't know: there was no need for congress to pass a bill to save the commercial paper market, because the Fed could buy it directly. We know this because the Fed DID buy giant amounts of it, over $300 billion -- but not until October, well after TARP had passed.

So in September, Bernanke was saying: "Help! We need $700 billion or else the commercial paper market will destroy the world!"

Then a month later in October, Bernanke quietly went ahead and saved the commercial paper market, using non-TARP money -- something he could have easily done the month before.

This can all be seen in the above graph that I made. The Fed balance sheet exploded starting in mid-September. They spent $500 billion by October 1st, two days before TARP passed. They spent $1 trillion by the time the first trickles of TARP money were allocated in late October. (This in itself is damning -- we had to give them the money or else Planet Earth would explode, and yet it took Paulson three weeks to dole out the first TARP sliver.) All along, the Fed side of the bailout had dwarfed TARP.

Yet it's been completely invisible. While we were all screaming about that little pink line, the Fed was carrying out the real bailout via the blue line and we never noticed.

And most of amazing of all, to this day the Fed refuses to say exactly what they've bought for $1.3 trillion. Seriously -- congress has asked, and the Fed has basically said: screw you. (NOTE: Since I wrote this, the Fed was forced, over its loud objections, to disclose what it purchased.)

Now, for the final proof this was a scam: several months after TARP passed, the New Yorker profiled Ben Bernanke. In the article, Bernanke claims he said this to Paulson on September 17th, after the AIG bailout: "We can’t keep doing this. Both because we at the Fed don’t have the necessary resources and for reasons of democratic legitimacy, it’s important that the Congress come in and take control of the situation."

Sounds good, doesn't it? But if you think about it for two seconds, it's obvious crap. #1, look at the graph --the Fed had the resources and wasn't shy about using them. #2, the high-pressure way they sold TARP and the Fed's ongoing secrecy demonstrates how much Bernanke cares about "democratic legitimacy."

—Jonathan Schwarz

Posted at November 27, 2011 10:28 PM

I'm pretty sure Taibbi has ranted about the Fed's bottomless coffers, their acceptance of phony-baloney MBSs as collateral, and the trillions given away in non-TARP programs that no one pays any attention to, so it's not exactly fair to say "no one" in the media has been saying this.

Posted by: saurabh at November 27, 2011 10:50 PM

Well, I said "essentially." Plus I think literally no one has made the commercial paper-WMD connection.

Posted by: Jonathan Schwarz at November 27, 2011 10:56 PM

The fed can buy what it wants, sell what it wants, invest in what it wants, no law against it. WE're printing OUR way to 700 trillion and funneling it into the banks through AIG. THAT'S WHY U&I bought the biggest and bestest insurance giant to balance the books. I'd love a look at them myself.

Posted by: Mike Meyer at November 27, 2011 11:31 PM

I am not so sure that I didn't read it here...that since we now know the FED loaned 16 trillion...why didn't they simply pick up the costs of TARP? That is the real question. Why make us do that? Just a distraction....nah I've thought all along it was a means to co-opt all of Congress which they already had in their pockets. Make them culpable and force Congress to keep their mouths shut while they stole tax money from idiots. Pretty sinister.

Posted by: Frankenstein Government at November 28, 2011 03:13 AM

Jon--I don't have time to play long, so where's the information disclosed by the Fed at the link you provide, because I'd love to see it. I got claustrophobic when I clicked on it and didn't see what you were referring to.

You're right that "democratic legitimacy" is code, but also remember that although capitalists all eat the poor, that isn't their entire diet--they also eat each other. They all have lobbyists and make contributions to political campaigns and use "democracy" as they can, and just as the big--like AIG and Lehman--can collapse suddenly, others can grow a lot suddenly in periods of volatility and become powerful fast. (Meet the new boss, same as the old boss, except the new boss remembers how you tried to screw him)

Bernanke was perhaps expressing that he did not want to be swimming in the middle of a bunch of sharks in a feeding frenzy--better to let those guys in Congress do that.

Posted by: N E at November 28, 2011 06:48 AM

If the Fed can refuse to tell Congress what it is doing, then who is really in charge of the country?

Posted by: seth at November 28, 2011 08:45 AM

Thanks for explaining this Jon.

I'm more than a little confused by this new (from the Bloomberg link - $1.3 Trillion) number. Didn't the GAO release a report this past July stating that the amount loaned to banks was $16 Trillion?

Also, not that you're responsible for their reporting, but the Bloomberg story says that the banks "reaped" $13 Billion by taking advantage of below market rates. That seems awfully low compared to the amount of money they had access to.

Posted by: Bruce F at November 28, 2011 10:59 AM


What I have heard that accounts for that $13 Billion figure was this: the Fed lent enormous sums of money to the banks at .25% interest, and the banks turned around and bought T-bills with it at about 2% interest. They made their money on the interest rate differential. Pretty sexy. They could count the T-bills as assets, part of the capitalization of the bank, while making money off of the interest on money they were pretty much handed - to, of all things, raise their capitalization. Of course, they made this money out of the taxpayers' hide. Whoo hoo. So even when they have massively fucked up, their friends down at the Fed banking cartel, after saving their hash from the logical consequences of their abysmal stupidity, engineer it so that they exact even more money from all of the rest of us, laundered through the front-room operation of the banking cartel. Sweet.

N.B.: If my understanding is incomplete in part or in whole, somebody else please take a whack at it. Not me, please. I'm only the oboe player.

Posted by: JerseyJeffersonian at December 6, 2011 06:28 PM

Its a printing game JerseyJeffersonian. YOU are being PRINTED into saying what IS YOURS actually belongs to someone else. And its ALL done with a printing press.

Posted by: Mike Meyer at December 6, 2011 08:40 PM