Fallout: The Financial Crisis

Ca-ching goes the Federal Reserve

Rico Gagliano Oct 23, 2008
Fallout: The Financial Crisis

Ca-ching goes the Federal Reserve

Rico Gagliano Oct 23, 2008


Kai Ryssdal: Let’s go down the list of companies the Federal Reserve has bailed out, just to refresh our memories here for a second. We got Bear Stearns, Fannie Mae, Freddie Mac and AIG. Those are just the ones we know by name, of course. Because over the past year or so, the Fed has pumped hundreds of billions of dollars in straight cash into the banking system. And as the financial crisis has worsened, Mr. Bernanke has said he’ll shell out hundreds of billions more in loans and special financing programs. Add it all up and all together, the Fed could be on the hook for an estimated $1.4 trillion. To find out where all that cash is coming from, Rico Gagliano has the first installment of our new explainer series the “Marketplace Decoder.”

Rico Gagliano:
Remember back in March? Good times. The election was still far enough away to ignore. Unemployment was a merely lousy 5.1 percent compared to September’s awful 6.1 percent. And the Federal Reserve?

Paddy Hirsch: The Federal Reserve was sitting on a huge stash of treasury bills. That was their biggest investment: about $800 billion in treasury bills that they bought on the secondary market.

That’s Marketplace Senior Editor–and one of our resident Fed experts–Paddy Hirsch. He says the Fed kept that $800 billion on hand to sell when it needed cash. For stuff like controlling the nation’s money supply. A rainy-day fund, if you will. Then–Tropical Storm Bear Stearns hit. Followed by hurricanes Fannie Mae, Freddie Mac and Lehman. Rainy-day fund in effect.

From March through September, the Fed was selling off those treasury bills that it had and using the money to buy other stuff. You know: to help out Bear Stearns, to extend other kinds of loans it had never made before. So by about mid-September they’d blown through about $350 billion.

OK, so that’s where some of the bailout money came from. But this well has run dry; the Fed needs the remaining $400-plus billion in case of apocalypse–otherwise known as rampant inflation. But since September, the government pledged at least a trillion more in bailout money and other aid. So, Paddy, where’s that cash coming from?

Well, Rico that’s coming from the Fed’s magic ATM machine.

Yes, the magic ATM machine. You can find it in Ben Bernanke’s office, guarded by cute but powerful elves. He inserts a jewel-encrusted wizard card and out pop debt-free dollars made of purest gold.
No, not really. Marilyn Cohen is president of Envision Capital Management.

Marilyn Cohen:
The money has to come, not out of thin air–but from the U.S. Treasury. And since they don’t have a surplus–they have a deficit–they will print treasury notes and treasury bonds. And sell them to small investors, to large institutional investors, and to foreigners.

Create IOU’s, in other words–more than $500 billion worth so far. That of course puts us further into debt. How much further depends on how many more IOUs they sell, and on how much interest they have to pay to get people to buy. Obviously the Treasury will try to keep rates low.

And, um, if nobody shows up, or very few show up, then it means it was priced wrong; that means that interest rates will have to go up. And that will be very bad for an economy that is declining like ours is now.

For the time being, though, many buyers are showing up. Why? Apparently they believe we’re still one of the safest bets out there. Johs Warsoe is Senior Executive VP at Union Bank of California.

Johs Warsoe:
There’s continuously lots of appetite to buy U.S. Treasuries. They’re gonna issue Treasuries–they’re doing that–typically very short-term bills at this point in time, paying 1, 2 percent.

The Treasury hands cash from those sales to the Fed, which Warsoe says then lends it to banks, at rates as high as 7 percent. So, assuming enough banks survive, the Fed could make money in the long term. But in the short term, trust me.
You don’t want to look at that ATM receipt.

In Los Angeles, I’m Rico Gagliano for Marketplace.

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