TARP, Yet Again: Inflationary?
Back in the old days of derivatives (the mid-1980s), there was an international commercial bank that was famous for declaring how much good derivatives had done for it.
It was famous because it was common knowledge in the marketplace that the bank would have its swap counterparties “buy out” the positions where it was due money, while those on which it had a debit debit were kept on its books.
So I wasn’t exactly either surprised or believing when the NYT announced, to much fanfare, that there was a “profit” being made on the bailout funds. As Bruce Webb noted here at the time:
These early returns are by no means a full accounting of the huge financial rescue undertaken by the federal government last year to stabilize teetering banks and other companies.
The government still faces potentially huge long-term losses from its bailouts of the insurance giant American International Group, the mortgage finance companies Fannie Mae and Freddie Mac, and the automakers General Motors and Chrysler. The Treasury Department could also take a hit from its guarantees on billions of dollars of toxic mortgages.
But it got nice headlines at the end of August, when talk of “green shoots” and “inflation fears”needed to get momentum.
Featured less prominently is a now-week-old LAT article with a more realistic perspective:
The Treasury is unlikely to get back the full amount of money lent under the Troubled Asset Relief Program despite a recent spate of repayments from large banks, warned the program’s watchdog.
The program “played a significant role” in rescuing the financial system from a meltdown, Neil Barofsky, special inspector general for TARP, testified before the Senate Banking Committee on Thursday. But it was “extremely unlikely that the taxpayer will see a full return on its TARP investment,” according to his prepared testimony.
The official story remains that the large banks will be paying everything back. If that’s true, then the answer to Rebecca’s question of how to drain liquidity from the financial system is clear: take the paybacks and disappear the monies. It’s only if there is an excess shortfall on the securities that excess money will be in the system.
So, if the NYT was correct at the end of August, or the cheerleaders are correct now, there will not be an inflation issue, or an excess bubble, just a little “extra lubricant” making certain that valuable securities attain their full value that will naturally be removed from the system (both as cash and as Lines of Credit) as the value is realized.
Indeed, the only reason to fear inflation from TARP/TAF sources is if you expect a significant shortfall in the actual values, something for which you can only compensate by leaving a large quantity of excess lendings in the market. Which, by definition, will not and cannot happen if all the major players repay their allocations in full (let alone with interest).
Second derivatives don’t make inflation. And money loaned by the Fed that is fully repaid doesn’t make inflation unless it is loaned out (“multiplier effect”), which hasn’t been and still isn’t happening.
What there is is “excess” cash sitting on bank balance sheets in lieu of full repayments. But it’s not being used for other things—no multiplier effect—and it can be disappeared by the Fed as it is paid back.
So where is the inflation, unless money has been added to the system without there being value behind it?
Somewhere, an old derivatives manager is watching. Maybe he recognizes his strategy in the story unfolding. Maybe, just maybe, he also kept underlying deals that didn’t have losses as big as the gains he took.
It’s possible. But it was never the way to bet.