Tuesday, April 14, 2009

Paying back TARP is a cost to taxpayers!

Many detractors of bailouts usually invoke the “Theory of Loanable Funds” when arguing against such measures. This theory suggests that when the government deficit spends (for anything), it takes funds away from the private sector, which could have been used for other, more productive uses. Therefore, deficit spending—whether for national defense, transfer payments or bailouts—only constitutes a “redistribution” of wealth and nothing more.

What they miss is the fact that when the Treasury spends (for anything) it results in an increase in reserves in the banking system and those are the funds used to buy the securities that “fund” deficit spending. In other words, the money is provided by the government itself and therefore, does not take anything away from the private sector. On the contrary, it adds to private sector wealth in the form of a greater holding of one asset—Treasuries.

On the other hand, when private firms pay back TARP money (which was just created simply by a keystroke on the government’s spreadsheet), the result is a net reserve drain: The funds go from the private sector to the Treasury and literally, disappear. The banking system is left with fewer reserves and, all else being equal, the public loses.

I say all else being equal because, in reality, the Fed will replace those funds if the reserve drain results in an unwanted increase in its overnight lending rate. However, given the current level of reserve balances the Fed may decide to leave system reserves lower by the amount of TARP money that has been paid back, so the public loses.


Unknown said...

I think I saw Glenn Beck saying that treasury bills are "full of cancer" just before the guest passed out on the floor.

The graphic he had up also suggested the US governmnt is headed towards bankruptcy. He should really try to learn about things before he goes on TV talking about it.


mike norman said...

Yes, his "explanations" are grotesquely innacurate and one of the most blatant examples of purposeful misinformation that I have seen or heard of.

Warren Mosler said...

Hi Mike,

Here's how I see it:

When tarp funds are repaid the private sector loses a financial assets (the balances paid) and a financial liability (the funds owed to the govt.)

so net financial assets and financial 'net worth' of the private sector remain unchanged.

This was also the reason the Tarp and other financial asset purchases of the Fed and Tsy didn't do much- they were just exchanges of financial assets.

Am i missing something?


Unknown said...

I think Warren is right. Mike is correct that spending would have increased the financial wealth of the private sector, but TARP as I understood it was always meant to be a loan and not contribute to deficit spending.

If they had been handouts rather than loans, people would have been piiiiiissed!

Unknown said...

Actually I think a lot of the opposition to TARP was people saying that the government might not get all the money back. If that happens and those loans are written off, would that be an increase in net financial wealth?

Anonymous said...

Michael, I think that's correct. And then there's a flip side in that when TARP money is repaid it is accompanied by interest and therefore the financial wealth of the private sector ends up netting a loss .