Did You Hear The One About The 29 Trillion Dollar Bailout?

I’m reluctant to link to pieces that further the goal of miseducating the public, but I’m guessing you’re going to run into this nonsense at some point in the next few days anyway.   Miscounting of revolving loans leads to numbers which whip the layman into a state of hysteria – but distracts from the real issue at hand (which I’ll get to in a moment).   Such miscounting, however, is great for blatantly manipulating the sentiments of Those Who Do Not Know Any Better.     Never mind the fact that the Fed Chairman himself already explained the difference between borrowing $1 overnight and rolling the loan for 365 days, and borrowing $365.   Bernanke also already explained to you that if you take out a mortgage for $ 500k at 5% and refinance it twice, it would not be correct to say that you’ve now borrowed $ 1.5MM.

Alea took another crack at this concept yesterday, with a table of the term-adjusted loan balances.   But part time bloggers are no match for the misinformed/misleading/downright wrong (take your pick) rantings of Alan Grayson, Jon Stewart, and Professor L. Randall Wray.  Today, Alea pulls Wray’s most inapt analogy, preserving it in all it’s misapplied glory (and critiquing the ignorance of it on Wray’s own post):

“Think about it this way. A half dozen drunken sailors are at the bar, and the bartender refills their shot glasses with whiskey each time a drink is taken. At any instant, the bar-keep has committed only six ounces of booze. That is a useful measure of whiskey outstanding. But it is not useful for telling us how much the drunks drank. Bernanke would like us to believe that if the Fed newly lent a trillion bucks every day for 3 years to all our drunken bankers that we should total that as only a trillion greenbacks committed. Yes, that provides some useful information but it does not really measure the necessary intervention by the Fed into financial markets to save Wall Street.”

As I noted in a comment on Ritholtz’s blog on the topic this morning, I believe that the proper analogy would be that the sailors don’t drink the whiskey in their glasses – rather, they flaunt their liquid wares (if it’s not obvious, we could call this LIQUIDITY) to the lady suitors at the other end of the bar: raising their shot glasses suggestively in the ladies’ directions while winking…   Then, they turn around and pour the whiskey back into the bottle (repaying the loan), and repeat the exercise in an hour when a new batch of ladies comes into the bar.

I think that the most succinct/accurate comment on this issue I’ve read thus far is from @JamesEliot on Ritholtz’s post, which points out that the hypesters are conjuring up nonsense while simultaneously missing the real problem:

 “Ridiculous. The numbers are big enough without having to engage in a silly addition exercise to gross them up even further. Ask yourself what the Fed’s maximum aggregate credit exposure on any given day during the relevant period was. It was nowhere near $29 trillion. Sure, rolling over short term debt continuously betrays the lie that it was short term, but the Fed’s credit exposure didn’t double on the rollover: the first loan was REPAID with the proceeds of the rollover. So, it’s just sophistry to add the second to the first and suggest that this was the Fed’s (and by extension, the taxpayers) real risk.

I don’t know what the point of this sophmoric distortion of the record is intended to accomplish. You don’t need to engage in double and triple and quadruple counting (such as Randy does) to conclude that the Fed’s intervention was enormous and unprecedented, that the banks who required that intervention for their very survival had grossly mismanaged their liabilities and balance sheet risks and that fundamental reform of a system that allowed them to lever up so recklessly and to rely on the Fed’s bailing them out so assuredly is required.”

Which brings us to the real issue: enormous intervention by the Fed – intervention so huge that it’s still huge even if we don’t quintuple count it (or more) – and the lack of reform to ameliorate the potential need for such intervention again in the future: by which I simply mean that these Big Bank balance sheets are not shrinking.*   More importantly, the length of the intervention is the problem (not the cumulative notional!).   Overnight liquidity constantly rolled can’t be summed in terms of notional dollars – that’s the theme I’ve been trying to get at here.   HOWEVER, the question should be:  “Why the f*ck should The Fed need to be lending these banks money every day for months and YEARS?”   If the problem lasts for extended periods of time, it means that the bank’s business model/balance sheet management is inadequate.   The Federal Reserve should act as an emergency stopgap – not a constant ongoing liquidity provider.

I believe in the Fed’s role as lender of last resort – that’s a short term stopgap where the central bank lends against good collateral during periods of dire illiquidity.   If such periods are lengthy in nature, it means that the borrowing banks need to change their business models – the Fed should not be a long term crutch used to fill liquidity holes in massively over-levered balance sheets.

It’s essential that we focus on these real issues, and not get distracted by sideshow headline numbers which distract from the ultimate problem.


* I suppose one could argue that the pending Basel capital rules are intended to address this issue.  I hardly think they solve it, though.

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