I keep reading that "the taxpayers bailed out Bear Stearns." I realize that such an implication makes for a great headline, but is it true? If the assets held by Bear Stearns truly have no market value, who loses? The Fed? The taxpayer?
How does the taxpayer, or anyone other than the Fed, and its member banks, lose? The Fed is not tied to the Treasury (in theory, anyway), so how are the taxpayers liable for any loss. I recognize that reduced value of its assets means the Fed will have to reduce loans to member bank, which will cause downstream stress. But how do the taxpayers ever end up footing the bill (under current law).
The Fed guaranteed $29 billion of Bear's assets (or liabilities) with JPMorgan putting up $1B.
If in the long term they turn out to be a loss the Fed (AKA the taxpayer) is out $29B while JPM is only out $1B. If they don't lose value then JPM gets its $1B back with interest.
If they turn out to be partial losers the Fed gives JPM whatever is left of their $1B after they get their initial investment and interest if indeed there is any money left over.
It's a crap shoot which way it'll go since I think there is a 10 - 20 year time span involved, can't remember exactly.
Unless you're asking how the Fed gets to socialize its losses which I'm not quite sure how that works since I've never looked into it.
Anonymous Coward:Unless you're asking how the Fed gets to socialize its losses which I'm not quite sure how that works since I've never looked into it.
That is exactly what I am trying to understand. Because the Fed is not the taxpayer, how is the taxpayer liable under current law. I use the qualifier current since laws can always change.
JFedako:That is exactly what I am trying to understand. Because the Fed is not the taxpayer, how is the taxpayer liable under current law. I use the qualifier current since laws can always change.
There is no such thing as a free lunch - this is always always always true (no exceptions). What would happen if, for example, I bought some stocks tomorrow on margin and lost all my money... I was bankrupt and the Fed said, hey that's cool, we'll take your really bad investments and give you our solid government treasuries. That's effectively what's going on with Bear Sterns. Now ask yourself the question, if it really does prevent me from making losses and the Fed really does "absorb" those losses, what's to stop the Fed doing this for EVERY person who ever makes a mistake on their investment and looses money on their margin trades? The Fed starts loosing a lot of money right? Sure, but what are the Fed's assets? They're primarily government treasuries right? But how does it get those assets? It buys them - with money that it creates out of thin air... this is where new bank reserves come from.
So the Fed doesn't really make losses - losses are completely irrelevant to the Fed since money supply is infinite for the Fed. Sure, it's assets are reduced in this case, but what the Fed does make is money and so if the Fed's assets go down to zero or even negative 40 billion, they can always magic some more money into existence to monetize that debt. In fact, whether they do this at the moment they buy the Bear Sterns bad debt, 2 weeks later or 2 years later, since all of the Fed's assets ultimately come from money created out of thin air, when it buys bad debts from the public the Fed is effectively promising to monetize those debts at one stage or another... and those who pay for the monetizatino of debt and indeed all new money are those that have savings - not tax payers at all. So you're quite right, it's not tax payers that will pay for this but ultimately savers (as usual, since savings are what's used to pay for all investments, including those that fail just as much as those that succeed).
The biggest problem in all of this is not when the debt will be monetized (as it eventually will) but the implication that whilst you or I must realize our losses the big banks don't have to. They can make bad investments and loose money and still end up with the same sum on their balance sheets - effectively the Fed gives them back all the money they lost at the expense of anyone who has savings at that point in time. The problem with all of this is moral hazard - which I believe most of the lame economists you hear rambling in newspapers and on TV seem to think implies we need more regulations to prevent in the future... which is complete *** - what we need is for banks to be treated just like the rest of us... which is to say :
Furthermore, accounts depositors at banks should know that they can either deposit their money in a cash account (in which case it remains available to them to withdraw WHENEVER they like, including after their bank has gone bust, since this cash remains the asset of the custoemr) or they can put their assets in savings accounts (which attract interest but which they run the risk of not getting back, since their bank might loan this out and subsequently go bankrupt). In this case, when banks do go bust the depositors wouldn't be treated as special cases either, since they knew very well when they loaned the money to the bank (i.e. opened a savings account) they were taking a risk... just as banks take risks by loaning money to mortgage holders.
Using such a system banks wouldn't be able to loose more money than they actually had and nore would they be able to loose other people's money...
Jimmy,
I agree with everything you wrote. My concern is that government -- via the politicians -- is about to add regulation upon regulation, all in the name of the taxpayer. I simply disagree that the taxpayer is liable and, hence, in need of government protection. The issue is the Fed, not the market or Bear Stearns. Yet, by claiming defense of the taxpayer in a world of uncertain markets, we all will suffer.
note: Of course, it is the Fed that creates much of the market uncertainty. The rest of the uncertainty is the risk that is involved with any entrepreneurial endeavor.