AIG bailout. Where did the money come from

[69dodge]

The Fed has the privilege to buy notes from the Bureau, treating them as physical products that have been manufactured. Last I heard the price of notes was something like 3% of face value.

To expand on Gaz' response, here's a .pdf from the BEP the intro of which contains this quote. I put the purchase with the wrong agency (banking institutions buy it, not the Fed. they just order it from BEP/Mint).

Depository institutions, such as commercial banks, savings banks, savings and loan associations, and credit unions, buy currency from Federal Reserve banks to meet customer demand. The value of that cash is charged to their accounts and when the need for currency and coin declines, these institutions return excess cash to a Federal Reserve bank, which in turn credits the appropriate account.

It sounds like you're talking about different things?

Currency starts out as plain paper, worth a small fraction of the number printed on it. Somewhere along the line, a miracle happens, and it becomes real money. After that, a bank can get some only by giving up an equal amount of its reserves at a Federal Reserve Bank.

I'm trying to figure out exactly where the miracle happens. Who is holding the paper when it turns into money? (And how do I get their job?)

 

[a_unique_person]

One is a loan, one is a transfer.

If the government loans me money or gives me money, it still has to come from somewhere.

 

[UnrepentantSinner]

The bills and coins are money as soon as they're printed/minted. As the BEP site noted (and I corrected above {"I put the purchase with the wrong agency (banking institutions buy it, not the Fed. they just order it from BEP/Mint).}) they provide the Fed with that money and the Fed issues it to banks, credit unions, etc.

As evidence I present the framed sheet of $2 bills purchased directly from the BEP by my parents for me. Should I ever need or chose to, I could cut that sheet up and use the $2 as currency.

 

[Francesca R]

If the government loans me money or gives me money, it still has to come from somewhere.

The Treasury does not need to issue debt to finance a Fed loan like this. It does need to to finance a one-off tax cut.

 

[leonAzul]

Challenge the constitutional aspects with greater authorities on the subject than me by all means, I am not even American. In any case, the rational, public-interest reason *why* most governments give their central banks executive powers to lend-as-last-resort is that it is wholly self-defeating to require legislatures to mull over the pros and cons in the midst of a crisis. Quite obviously the outcome of such a setup would be that Bear Stearns and AIG would go down and we would now be discovering how bad the collateral damage actually was.

(Again, it is a *loan* not a transfer) Fair enough. But I think your misguided sense of principle would be much more threatening to taxpayers.

Struth. It is a loan, and that is why there is a federal reserve. And if AIG defaults, then we all have hell to pay.

 

[leonAzul]

Y'all have no idea how serious this is. Do you want to own a car? Then you need insurance on the loan. Do you want to buy a house? Then you need insurance on the loan. Unless you are so full of cash money that you can pay.

 

[Meadmaker]

Struth. It is a loan, and that is why there is a federal reserve. And if AIG defaults, then we all have hell to pay.

We have hell to pay, but do we have money to pay?

I'm not following that part. Let us imagine that AIG takes the money, spends it, and it turns out that the 1 trillion dollars in assets were actually futures contracts betting on the rise in Zimbabwean dollars. In other words, let us suppose the value of their assests, auctioned off, is nowhere near their liabilities, and they cannot pay back the Fed one red cent. They took the money, spent it on copier paper, and ran their total account down to zero.

Now, we are told, the taxpayer is on the hook. To whom?

Let's take AIG out of it, and move to hypothetical future bailout. Dave's Meadery has a thriving business and has made tens of thousands of bottles of mead. Unfortunately, mead hasn't been selling quite as well as he would like, and he had a loan on the meadmaking equipment. He can't pay his bills. It's not that his business is a miserable failure. He's just in a cash crunch. As soon as those mead bottles sell, there will be no problem. He as 20,000 bottles, and each one is worth 500 dollars. It says so right on the balance sheet. So, he has ten million dollars in assets, but he has a mere 1 million dollars in unpaid bills. All he needs is a loan to tide him over until the next payday, when lots of people will go out and buy mead. Then, he can pay back.

No bank will lend him the money. Since these are unusual circumstances, and no other lender will touch Dave's Meadery with a ten foot pole, the Fed is authorized to lend the money. They decide to do so. They make some new money, give it to Dave, and make him promise to pay it back with interest.

Well, payday comes and goes, the Fed asks Dave what happened to his scheduled loan payment, and Dave can't find the money. The Fed gets hopping mad and seizes the assets. "Hand over the mead, Dave!" Unfortunately, it turns out that as part of a marketing campaign, Dave gave all the mead to people who attended one heck of a party, and the new money went to pay Dave's very reasonable CEO pay granted him by the board of directors, also known as Dave's Brother-In-Law.

So, there's no money, and no mead. Dave's Meadery can't repay the loan. The Fed can't sell the assets, because there aren't any assets to sell. The taxpayer is on the hook for the loan, we are told. To whom does the taxpayer owe the money?

 

[69dodge]

So, there's no money, and no mead. Dave's Meadery can't repay the loan. The Fed can't sell the assets, because there aren't any assets to sell. The taxpayer is on the hook for the loan, we are told. To whom does the taxpayer owe the money?

You shouldn't believe me, because I don't know the first thing about this stuff. But I will guess anyway. The taxpayer needs to pay as much money as Dave's Meadery was supposed to pay, to whomever Dave's Meadery was supposed to pay it. Namely, to the Fed. And then the Fed will do with the taxpayer's money exactly what it would have done with Dave's Meadery's money. Namely, cause it magically to disappear along with the record of the loan, in much the same way as it caused it magically to appear in the first place.

 

[Francesca R]

Now, we are told, the taxpayer is on the hook. To whom?

The FRBNY can't "forgive" the debt. Since the US government owns most of AIG and the US government is (still) solvent, then it pays off the loan and gets the money from you.

 

[Gazpacho]

I don't want the government to be able to give 85 billion dollars to a private company without a Congressional vote.

Aside from the fact that money has not been given, the Fed was created precisely to address situations where a vote would not be possible: situations where a company that is tangled up in the economy is out of cash right now and needs time to untangle itself without collapsing the US dollar.

As for your hypothetical situation, I'm not able to translate it into any plausible situation involving a financial institution.

 

[Meadmaker]

The FRBNY can't "forgive" the debt. Since the US government owns most of AIG and the US government is (still) solvent, then it pays off the loan and gets the money from you.

So, part of the deal was that if AIG didn't pay back the money, Treasury would? Treasury guaranteed the loan? That's why the taxpayer is on the hook? Does the Treasury Department automatically guarantee every loan the Fed makes?

The scenario I suggested has nothing to do with "forgiving" a loan. If I borrow a bunch of money from the bank, and then die suddenly with no money in the bank, the bank doesn't "forgive" the loan. It still has a claim on the assets from my estate, but if I don't have an estate, they don't get their money. It's not a matter of "forgiving" anything. It's just that you can't get money from someone who doesn't have it, or the ability to get it.

If AIG goes belly up despite the loan, that would be analogous to me dying. However, it seems that the Treasury was a cosigner on that loan. If AIG can't get the money, Treasury (i.e. us) pays back the Fed. That's what I'm reading.

If that's the case, then the government just spent a bunch of money without Congress' approval. Oh...no...it loaned a bunch of money without Congress' approval. This is one heck of a bad precedent.

I vaguely recall when Chrysler was on the verge of bankruptcy a few decades ago. Walter Mondale led the effort to pass a bill to save them. That was Senator Walter Mondale. He was a member of Congress. That's what Congress does. It spends money. It was 1.5 billion bucks, but he got the votes to do it.

Who voted for this bailout? Why didn't we need a latter day Senator Mondale? I can read the law that says the Fed has the power to loan money if it feels like it. Ok. Fine. That's risky, but I can see why it has to. But that wasn't all that happened. In addition to making the loan, apparently the Treasury Department guaranteed the loan. It seems to me that that exceeded the power of the Treasury Department.

ETA: Mondale was VP at the time, but he was the Carter administration's point man on pushing the bill through Congress. This time...no Congress.

 

[Francesca R]

The scenario I suggested has nothing to do with "forgiving" a loan. If I borrow a bunch of money from the bank, and then die suddenly with no money in the bank, the bank doesn't "forgive" the loan. It still has a claim on the assets from my estate, but if I don't have an estate, they don't get their money. It's not a matter of "forgiving" anything. It's just that you can't get money from someone who doesn't have it, or the ability to get it.

If AIG goes belly up despite the loan, that would be analogous to me dying. However, it seems that the Treasury was a cosigner on that loan. If AIG can't get the money, Treasury (i.e. us) pays back the Fed. That's what I'm reading.

Well substitue "forgiving" with "writing off" this debt and accepting default with no recovery. But AIG going under and not paying would be--effectively--a nationalised industry defaulting to its most senior creditor, which is effectively the government defaulting on its debt (to its central bank). And that isn't going to happen (though I must admit you've got me on the precise flow of events that would sort it out).

 

[Gazpacho]

If that's the case, then the government just spent a bunch of money without Congress' approval. Oh...no...it loaned a bunch of money without Congress' approval. This is one heck of a bad precedent.

Lending operating cash to a hosed financial institution that is about to collapse right now and take the US dollar down with it, isn't a "precedent." It's what the fed was created to do.

You'll notice that as part of this arrangement, the Fed chose a new guy to oversee the company. I would imagine they trust him.

 

[Blackadder]

Thanks everybody for questions asked and answered. I learn a lot here, a lot more than from the newspapers.

 

[Merko]

The AIG deal doesn't necessarily hurt US taxpayers, because the government actually got stocks in AIG, so the money wasn't "lost". Look at it as an investment. Normally, governments don't make that kind of investment (unless it's Venezuela, Bolivia, or some other socialist country). And in this case, the investment certainly wasn't prompted by the great opportunity for quick returns. Still, it's not unlikely that taxpayers may end up as winners. Of course, one must also weigh in the costs for taxpayers if AIG had been allowed to fail, but then one must also look at other options for government intervention.

If I was a US taxpayer, I'd be more worried about the proposed deals to buy up packets of 'bad loans' from various financial institutions more generally. These schemes look far more suspicious, because it's extremely hard to make an independent valuation of these 'bad loans'. I'd definitely prefer buying some or all of these companies at stock market prices. That would also practically guarantee that bank owners would do their darndest to survive without any government bailout. Being able to sell off 'bad loan' packages, on the other hand, could very well spiral into a free-for-all government bailout that would end up rewarding those who made the worst decisions.

 

[leonAzul]

I'm not following that part.

Because you have conflated the Federal Reserve with the US Treasury. They are related, yet not identical.

 

[leonAzul]

It sounds like you're talking about different things?

Currency starts out as plain paper, worth a small fraction of the number printed on it. Somewhere along the line, a miracle happens, and it becomes real money. After that, a bank can get some only by giving up an equal amount of its reserves at a Federal Reserve Bank.

I'm trying to figure out exactly where the miracle happens. Who is holding the paper when it turns into money? (And how do I get their job?)

Please wrap your mind around this:

Money is the medium of voluntary exchange among productive persons.

No more, no less.

Take a moment to read what I have just written.

 

[Meadmaker]

It sounds like you're talking about different things?

Currency starts out as plain paper, worth a small fraction of the number printed on it. Somewhere along the line, a miracle happens, and it becomes real money. After that, a bank can get some only by giving up an equal amount of its reserves at a Federal Reserve Bank.

I'm trying to figure out exactly where the miracle happens. Who is holding the paper when it turns into money? (And how do I get their job?)

The miracle happens when the Fed loans it to someone. Up until that, it's just paper (or electronic blips). At the point it leaves the Fed, it becomes a promise to be honored as part of the economic system, and to be able to be used to pay all debts, public and private, like it says on the front of the bill.

When it gets repaid to the Fed, the money vanishes. Dollar bills held by the Fed are just paper.

What I haven't figured out is how the Treasury fits into all this. The Fed creates money by loaning it out to its member banks, or, under Section 13-3, to someone who can't get a loan elsewhere. The Treasury Department is the one who handles real government money. They have to have real money to pay real bills. Treasury can't create money. When they don't have enough money, they have to borrow it by selling bonds (or similar instruments). Does the Treasury guarantee all Fed loans? I don't think so, but I am prepared to be corrected on that point. If the taxpayer is on the hook for the AIG loans, then it must be because the treasury is obligated to pay those loans if AIG doesn't. Is that normal? Is that part of the deal? Or is that always the case whenever the Fed makes a loan?

 

[Gazpacho]

What I haven't figured out is how the Treasury fits into all this.

The Treasury has the sole authority to issue currency (31 USC 5115). This is indicated, ceremonially, by the signatures on US currency. Typically the Federal Reserve must request, and the Treasury must approve, in order for new currency to be issued.

Does the Treasury guarantee all Fed loans?

That question doesn't make sense. A loan guarantee, in the usual sense, means that the government promises to pay bondholders outside the federal government if a borrower defaults. The Fed is part of the federal government.

If AIG defaulted on its debt to the Fed, and that default could not be recovered by subsequent measures, then the US dollar would take an inflation hit. I believe this is unlikely, and that AIG will carve itself down to a size where it can close its doors without many people caring. That is what Long-Term Capital Management did in 1998.

 

[Meadmaker]

If AIG defaulted on its debt to the Fed, and that default could not be recovered by subsequent measures, then the US dollar would take an inflation hit.

That's what I thought. However, other posters, particularly Francesca, seemed to think that was not the case. She said that the loan couldn't be written off. Those posters seemed to think that taxpayers were "on the hook" for the money. i.e. taxpayers would have to repay it.

That was contrary to my understanding of things. If AIG defaults, and if the sale of its assets doesn't cover the outstanding debt, my understanding was simply that now there were more dollars in the world, and the US dollar would take an inflation hit.

It seems to me that you and Francesca are not saying the same thing.

Can anyone enlighten me about whether Francesca and Gazpacho really are in agreement here, and I'm not understanding things? Also, if they really are different, who's right?