Wednesday, 9 December 2015

The $1.6 trillion gift by taxpayers to banks.

Working out the exact size of the subsidy or gift that taxpayers were forced to make to banksters is not easy. The following is back of the envelope estimate.

It seems from this source that the total amount loaned by the Fed to banks was $16trillion and the loans were at a zero or near zero rate of interest.

Now what would have been a realistic or appropriate rate of interest? Well Walter Bagehot’s famous answer to that was a “penalty” rate of interest, and in exchange for first class collateral.

One of the reasons for that penalty rate is that a borrower who suddenly finds their cash flow calculations are nonsense, is incompetent. Commercial banks themselves charge penalty rates to borrowers who suddenly claim they need emergency funding, and quite right.

As to exactly what that penalty rate should be, Warren Buffet loaned $5bn to Goldman Sachs at the height of the crisis at 10%. So presumably 10% is a fair “penalty rate”.

So roughly speaking, those Fed loans to banks were at zero percent, when in fact they should have been at 10%.

As to the duration of those loans, I don’t have exact figures, but to keep things simple, let’s say one year. On that basis, banks were subsidised to the extent of $1.6trillion. Or at least they were subsidised to the extent of $1.6trillion PER YEAR for however long the loans lasted.

The money came from thin air?

Several members of the revolving door brigade, with a view to claiming they weren’t subsidised at all, have claimed the Fed created the relevant money out of thin air (which it  did), and hence that the whole operation didn’t cost taxpayers anything.

That claim is blatantly dishonest. Reason is that there was an alternative to rescuing banks: the Fed, or more generally “the state” (i.e. central bank and government) could have dealt with the deflationary or recession inducing effects of bank failures by simply dishing out billions to the country’s taxpayers, and citizens generally. And/or the state could have implemented a large rise in public spending (something a left of centre government might have chosen to do).

Now you might claim that largesse towards taxpayer / citizens would have been a subsidy of taxpayers just as much as lending $16trillion to banks at a near zero rate of interest was a subsidy. Well the answer to that is that it’s widely accepted that it is the state’s job to maintain demand at a level that keeps the economy at capacity or “full employment”, whether there’s a bank crisis or not.

Central banks and Treasuries do that ALL THE TIME: i.e. they cut interest rates when appropriate, adjust the size of the deficit and so on. And that activity is not normally regarded as subsidy, and quite right.

Moreover, dishing out money created from thin air to taxpayers during a recession simply immitates the free market’s own cure for recessions (which in practice doesn’t work very well). That is, in a totally free and perfectly functioning market, and given a recession, prices and wages would drop, which in turn would increase the value of the monetary base, which in turn increases the paper assets of the private sector, which in turn induces the private sector to spend more. And that cures the recession. That’s known as the “Pigou effect”.

Of course in the real world, the Pigou effect doesn’t work very quickly because as Keynes famously put it, “wages are sticky downwards”. That is, if you try to cut wages, you often get riots.

In short, if the state dishes out money to taxpayers during a recession (e.g. by cutting taxes), all the state is doing is to IMITATE or bolster the free market’s cure for recessions.

And a subsidy is a payment which does not take place under free market conditions. Thus, in a sense, having the state print and dish out money to taxpayers or citizens in general is not a subsidy.

In contrast, there is absolutely no way that having the state dish out trillions to a very small and select group of firms, banks or any other group, is not a subsidy.


P.S. (11th Dec). David Andolfatto argues here that central banks should not charge penalty rates. In the comments, I stick to my view that the rate should be “penalty”.


P.S. (5th Jan 2016). My above $1.6trillion estimate is way out. I've done a revised estimate here:

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