False Profits? Bank Bailout Accounting

The NYT had a front page piece telling readers that the government is profiting on last fall's bailout of the banks. The tally to date presented in this article is a bit misleading. The banks that borrowed money were in very different conditions. Some were hopelessly insolvent, while other were fundamentally sound. The ones that have repaid their loans and provided profits on warrants were in the former category. The NYT is tallying up the profits on these loans.

The government has not yet recorded any losses from the zombies, most notably Citigroup and Bank of America. It is important to note that in the case of these two banks, the government has kept them afloat, after issuing its initial loans through the TARP program, by guaranteeing hundreds of billions of dollars of bad assets. If these banks end up using a substantial portion of these guarantees, then the government will end up a big loser, if they and all other banks repay their TARP loans.

It is also worth noting the origins of bank profits in the current economic environment. The Fed has pressed the short-term interest rate to near zero. This allows banks to borrow directly from the government at a almost no cost and then make loans, including to the government, at interest rates of 3.5 percent (10-year Treasury bonds) and higher.

If we create a situation in which banks can borrow money from the government at a low rate and lend back to the government at a considerably higher rate, then we can be sure that banks will have the money needed to repay their loans. However, this is a dubious way to make profits on investments.

http://prospect.org/csnc/blogs/beat_the_press