Want to know where the bailout money is really coming from? No, they're not printing it.

[HamdenRice]

I've read two contradictory kinds of posts on DU about where people think the money is coming from. Some people think the Treasury is just "printing it". Some people who say this understandably also predict that this has to lead to the eventual decline of the dollar and/or inflation, which traditional economic theory would indeed predict.

A second group believe that we are borrowing the money, which means that in the future we'll have to pay it back with interest, which will cripple our ability to accomplish other important goals, like providing universal health care or repairing our crumbling infrastructure.

Between the two, the second is closer to the truth -- but with a big proviso about the "paying back with interest" part.

Something extraordinary is going on in the financial markets, which is making this moment the perfect time for President Obama to launch a huge public works program while continuing and finishing the nationalization of the banking system: global investors are giving the federal government free money.

The reason that the scale of federal borrowing in a sense "doesn't matter" right now, and the reason that the usual concern about federal bond selling will mean that eventually taxes will need to cover the interest on those bonds no longer applies, is that the financial markets are so scared, and they are so desperate for a safe place to stash their money (federal treasury bonds being basically considered the only safe such place), investors are right now giving the federal government free money. To put it another way, when you calculate interest, maturity, and so on, the yield on federal bonds is effectively zero to the investor. They are saying, "here Uncle Sam, please take my money and hold it for me; I don't care if I don't earn interest, as long as I don't have to risk it on stocks and bonds, I'll be satisfied with your promise to return it in tact."

Right now, if you look at the coupon rate on 2 year treasury bonds, it's zero. That's right; institutional investors, foreign governments, pension funds, etc., are so scared, they are willing to give the government their money for two years with nothing in return. Longer term bonds are paying interest, but when you run orthodox calculations of yield, they are also near zero or at least historically low.

Even money borrowed at zero interest has to be paid back with tax dollars, right? If we were talking about, say, military spending, even with zero interest rates, the federal government would have to pay back its expenditures with future taxes. That's because once you spend a dollar on, for example, the military, you don't get it back.

But the federal government isn't making expenditures; it's making investments. Granted, those investments are very, very, risky, and at this point, and it seems to me that Paulson is so scared, scattered and incompetent, that he isn't doing the obviously necessary thing, which is to go further toward full nationalization of several banks. But because they are making these expenditures as an owner and investor, the stuff they are buying pays income.

For example, next year, the federal government will earn about $6 billion on $125 billion in preferred shares it purchased in one tranche of the bailout. But the interest it will pay on the money it borrowed to pay that $125 billion is much less than $6 billion in preferred dividends it will take in; after a few years those dividends will rise to $11 billion, but the feds will have locked in basically a zero interest cost to pay investors. If the bailout works (and if we want to survive, if we don't want to have the experience of Iceland, I think we have to hope it does) and the financial system eventually recovers, the banks will repurchase that preferred at face value for $125 billion, so the taxpayers will not have to pay for it.

Basically the federal government is becoming the biggest hedge fund in history (which didn't work so well for Iceland), but unlike any other hedge fund, it will have a massive amount of control over the economic conditions and interest rates it's betting on, and the money it's borrowing is being given to it for free.

[Skink]

1. If the Dollar strenthens the investors should make money.

[islandmkl]

3. they are 'protecting' their dollars versus further value-losses via stocks, etc.

the 'insurance' is worth the lack of interest...

[HamdenRice]

5. Yeah that's it exactly

In Japan, things got so bad that Japanese bonds had negative interest rates. Investors would pay the govt a small fee to hold their money for a year, so long as they were sure not to lose much more.

[Eric J in MN]

2. Henry Paulson guaranteed $250 billion of Citigroup's trash.

I don't think we'll get all of that back.

[HamdenRice]

4. Your right -- unless Obama has a comprehensive program to help homeowners

and restructure the underlying junk.

Buying the bad assets at their real value would work, especially with mortgage borrower help, but Paulson's latest approach -- buying the assets at inflated prices -- was his worst of all.

[Greyhound]

6. Absolutely right, it's an almost universal all-or-nothing bet and few will bet on nothing. n/t

:kick:

[Hawkowl]

7. Very well put

I would add that it appears that investors worldwide are worried about deflation not inflation. Meaning that even at 0% interest, their money will be able to buy more real stuff later rather than right now.

If Obama and the idiot congress can make the right investments, we may be able to merely escape the Great Depression II while wading through the most severe recession ever.

[HamdenRice]

8. Deflation

can indeed make zero interest attractive.

[sarcasmo]

9. If the money is being borrowed from China, this country is finished.

[HamdenRice]

10. Actually, that would be a very good thing

The crisis is caused in part by financial imbalances between China and the US. Because of our suspicions of China, we have severely limited where they can invest their surpluses, limiting them basically to financial assets like t-bills and mortgage backed securities, and credit card securities. This caused the spending splurge, the runup of assets and the bubble.

If China's surpluses were instead recycled through the real economy -- through a massive infrastructure program -- that would be a good thing, not a bad thing, especially because the interest rate they are charging (effectively zero) is lower than the benefits we are likely to obtain.

[Mike 03]

11. HamdenRice, I'm so glad you are here

You seem to have the ability to understand what is going on and patiently explain it those of us, like me, who tend to freak out and ask the same questions over and over again.

Thank you for being here and having the patience of Job. This is a post I will bookmark, print out, and read closely so I get what is happening.

I thought I understood this, but it's getting way beyond me. And it's getting frightening.

[HamdenRice]

14. Thanks

Your support helps a lot, especially since my trying to be rational and objective causes some DUers to call me a shill for the banks or worse.

[depakid]

12. Key point: "if we don't want to have the experience of Iceland."

I've observed (and inferred) from some comments that there are more than a few here who, for various reasons, want nothing less than a repeat of the Iceland experience on a much grander scale.

[HamdenRice]

13. "want nothing less than "

Yes, that makes sense. I post on DemocraticUnderground.com in order to persuade opinion makers of the world to turn the USA into Iceland.

:sarcasm:

But I acknowledge the risk that the Treasury and Fed are acting like a hedge fund, which is, as I said, very, very risky. On the other hand, the US has more control over its situation than Iceland.