Effect of Treasury's actions ( not the Fed's) on US money supply

Economics Economics Questions
1

Hi,

My question is regarding the effect on the US money supply of the recent bailout of Fannie Mae and Freddie Mac by US Treasury.

Ref: http://www.bloomberg.com.au/apps/news?pid=20601170&refer=home&sid=arwE9.fnm9JI

As far as I know, only the Federal Reserve can extend credit ( and therefore the money supply in the economy). What I don’t understand is how the Treasury is going to buy unlimited stakes in these companies and lend to them. Is the Treasury going to use funds from its tax revenue to do that? Note that the Fed has already authorized these companies to borrow from its discount window.

Thanks,

MG.

2

The answer is that it’s inflationary. If you have deficit spending to bailout Fannie Mae and Freddie Mac, then everyone else pays the cost as inflation.

The Federal government’s loan guarantee costs you money even if the Treasury never writes a single check. Because FNM and FRE have a loan guarantee, they may borrow cheaply. When they borrow, new money is printed. You pay the cost via inflation, even if a direct bailout never occurs.

FNM and FRE may borrow as much as they please, at a slight discount to the Treasury rate, due to the loan guarantee. If another corporation tried borrowing with such a lousy balance sheet, they would pay junk rates.

3

Thanks fsk.

I am confused here. I thought these GSEs borrow from the public market. The government’s guarantee allows them to have better credit ratings and therefore a lower cost of capital. It is also a common practice among corporations to guarantee the loans of subsidiaries.

Thanks again,

MG.

4

Let’s work a concrete example.

FNM borrows $1B from Citigroup at 2.5%.

Citigroup borrows $1B from the Federal Reserve at the Fed Funds Rate of 2%.

The Federal Reserve prints $1B of new money to loan to Citigroup. (Actually, $100M and the magic of fractional reserve banking creates the remaining $900M.)

FNM is borrowing directly from Citigroup, but indirectly from the Federal Reserve.

The net effect is that the average joe pays the cost of FNM’s borrowing via inflation. Even if the Federal government never pays a dime to back FNM’s debt, the guarantee means that FNM may borrow as much as they please.

This is a good deal for Citigroup. They’re borrowing at 2% and lending at 2.5%, making a riskless profit of 0.5%.

This is a good deal for FNM. They’re borrowing at 2.5% and buying mortgage bonds yielding around 6%.

Where does this profit come from? Citigroup and FNM aren’t doing any actual work, so the profit must come from somewhere. The answer is that everyone else is funding Citigroup and FNM’s profits via inflation.

Usually, when a large corporation guarantees the debt of a smaller corporation, they qualify for a bailout in the event of a disaster. Technically, JP Morgan Chase was responsible for most of Bear Stearns’ debt, because they were the clearing firm. In practice, JP Morgan Chase got a bailout. The bailout wasn’t free. Everyone else pays the cost as inflation.

The injustice is that if I want to borrow at 2% or 2.5%, I can’t. I have to pay more, and I can’t borrow as much. Inflation is 20%-30%, while FNM and Citigroup may borrow cheaply. Everyone else is subsidizing their profits via inflation.

If you consider Citigroup and FNM to be subsidiaries of the Federal government, then yes, it does make sense for their loans to be guaranteed.

Remember that. When you pay $5/gallon for gasoline, you’re paying for the profits of FNM, Citigroup, and JP Morgan Chase!

5

The Treasury is asking for a “blank check” from Congress, meaning that they’re asking for an unlimited budget to help bailout Fannie and Freddie. So, in an ideal world, that money would come from taxpayers and everyone would be really pissed. However, since we’ve been running deficits for a long time, Congress will probably borrow that money from the Fed to finance the “blank check,” forcing the Fed to print more money.

The same is happening with the Iraq War, the recently passed agri bill, etc. All of them “should” come out of taxpayer money but the reality is that the Fed is printing more and more to finance it because we don’t have high enough taxes.

6

It looks as though the Treasury is going to use its tax revenue to save the GSEs.

7

They estimate the cost of the bailout at $25B, which is IMHO low.

FNM and FRE’s debt is guaranteed by the Federal government. If you want to use real accounting instead of troll accounting, then ALL of their debt should count towards the national debt. This would increase the size of the national debt by 50%.