It’s the Fed, not the TARP

TARP vs. Non-Tarp Cumulative Distributed Funds

Source: Mary Bottari.

Mary Bottari has a good post on the Federal Reserve Bank’s role in the ongoing financial bailout. The media and voters have focused on the Troubled Asset Relief Program (TARP) legislation passed in a hurry late in 2008. But, as Bottari emphasizes, the TARP is only a minor part of the federal bailout of the banks.

As she writes: “TARP funds were a mere seven percent of total funds disbursed by federal government to aid the financial sector since 2007 … the more we focus on the much-despised TARP, the less we see the invisible hand of the Fed doing the heavy lifting.”

The most important elements of the government intervention on behalf of the financial sector have been Fed actions: low interest rates and Fed asset purchases. Rock-bottom interest rates have allowed banks to borrow money from the Fed at close to no cost and then to lend those funds to the Treasury at a several-percent, zero-risk, profit. (Maybe we should allow unemployed workers to form “banks” like these. It would take a lot of pressure off state unemployment insurance systems.)

The Fed has also purchased a lot of troubled assets from financial institutions, helping to clear those bad loans from the private sector’s balance sheets in quantities that dwarf the Bush administration’s TARP.

Where I differ from Bottari is on the implications for taxpayers. She argues that the Fed’s actions put taxpayers at risk. But, even if every asset the Fed bought suddenly lost all its value, US taxpayers would not lose a penny. The Fed’s balance sheet has nothing to do with the federal government’s taxes and revenues. The Fed has a limitless ability to print money. The only risk here is that the Fed’s actions increase the money supply and that this results in inflation. But, as with other discussions of Fed policy (quantitative easing, for example), the challenge we face now is deflation, not inflation, so the risks are slight.

UPDATE 12/12/2010: I’ve deleted an innacurate sentence from the original post and added another (about the Fed’s ability to print money) for clarification.

One way that the Fed’s balance sheet is linked to the federal government’s financial situation is through Fed payments to the Treasury. The Fed can (and does) send the interest payments from the assets it owns to the Treasury, increasing the federal government’s revenues. This is important in the current context because this means that the Fed can buy US government debt and refund the interest payments that the Treasury makes to the Fed on those purchases right back to the Treasury. Japan, for example, has used this financing strategy extensively, and my colleagues Dean Baker and Mark Weisbrot have urged the US and European governments to do the same now to cover the costs of necessary economic stimulus.

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