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False Profits? Bank Bailout Accounting
The NYT had a front page piece telling readers that the government is profiting on last fall's bailout of the banks. The tally to date presented in this article is a bit misleading. The banks that borrowed money were in very different conditions. Some were hopelessly insolvent, while other were fundamentally sound. The ones that have repaid their loans and provided profits on warrants were in the former category. The NYT is tallying up the profits on these loans.
The government has not yet recorded any losses from the zombies, most notably Citigroup and Bank of America. It is important to note that in the case of these two banks, the government has kept them afloat, after issuing its initial loans through the TARP program, by guaranteeing hundreds of billions of dollars of bad assets. If these banks end up using a substantial portion of these guarantees, then the government will end up a big loser, if they and all other banks repay their TARP loans.
It is also worth noting the origins of bank profits in the current economic environment. The Fed has pressed the short-term interest rate to near zero. This allows banks to borrow directly from the government at a almost no cost and then make loans, including to the government, at interest rates of 3.5 percent (10-year Treasury bonds) and higher.
If we create a situation in which banks can borrow money from the government at a low rate and lend back to the government at a considerably higher rate, then we can be sure that banks will have the money needed to repay their loans. However, this is a dubious way to make profits on investments.
--Dean Baker
COMMENTS (8)
When false prophets predict profits, are they false, profitable, or both?
When prophets compete, do they drive out bad prophets or bad profits?
What happens when a prophet is too big to profit? Is that different from a profit too little to prophet?
Is the NYT in it for the profit or the prophet?
Posted by: izzatzo | August 31, 2009 7:58 AM
Some were hopelessly insolvent, while other were fundamentally sound. The ones that have repaid their loans and provided profits on warrants were in the former category.
Perhaps you meant "latter" category?
Posted by: David R | August 31, 2009 9:51 AM
"The wonder of the dancing bear is not how well it dances, but that it dances at all."
Given the predictions of disaster and total write-offs of all moneys put out through TARP which has led to the rather breathless figure of $27 trillion in federal obligations floated by Barofsky news that not every dollar was just sent down the rat hole and that some is coming back with a dividend is a useful corrective.
BTW I posed a question at Angry Bear and have not yet gotten an answer. How does the $4 billion in dividends actually collected get reported for current year budget purposes? And per the article there is another $3.1 billion expected over the next month from JP Morgan and Capital One, which presumedly would be credited to FY2009, plus some $6.2 billion in interest receivable and paper profits of $18 billion in warrants. How did OMB and CBO treat these for the purposes of the mid-session review?
Posted by: Bruce Webb | August 31, 2009 2:21 PM
We should also include the enormous losses on the Fannie Mae and Freddie Mac bondholder bailouts, and the upcoming losses on at Ginnie Mae and FHA, which have taken over the role of making/guaranteeing sure-to-default mortgage loans to slow the disintegration of the housing market.
Posted by: jm | August 31, 2009 3:18 PM
JM that is exactly the same argument made against TARP, that all of the money was inevitably going to go down the rat hole.
We don't know how enormous those losses will be at Fannie and the others. The assets are toxic not because the value of the underlying loans are zero, because most of them in the end will perform, but because no one has a way of separating out the contamination. If we really could score the loan losses these assets would have a value. As it is people are equating the concepts of "uncertain" and "zero".
The belief that unmarketable assets have a value of zero is just an relic of EMH thinking. We don't need to get trapped in that frame if we don't want to.
Posted by: Bruce Webb | August 31, 2009 3:35 PM
Linus Wilson, the finance prof who did the profit calculations for the NYT article, sent me some numbers tallying the profits for four large banks that have yet to re-pay their TARP funds. On a risk-adjusted basis, they also show a taxpayer profit. As Dean says, of course, early days. My post here: http://bit.ly/v0Zb4
Posted by: Alain Sherter | August 31, 2009 5:32 PM
Dean,
Is there any calculation on how much the banks are benefiting by borrowing from the fed and buying treasuries.
I believe it is not a lot. According to the latest fed data - discount window lending was around $30B. At 3% spread that is $900 million a year, which is really not a lot for the whole banking sector. Plus I doubt that they are taking overnight funds and investing in 10 year treasuries since they carry a lot of interest rate risk. If they invest in shorter term securities the spread narrows quite a bit.
Do I have something wrong.
Thanks
Posted by: Rajat Chaudhry | September 1, 2009 12:37 AM
i like
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