Associated Press Has Some Interesting “Facts”

The associated press released a story yesterday in which they did a “fact check” on things that were said in the recent Republican presidential debate.  While the story went after several of the candidates, I want to analyze just the portion that was devoted to Ron Paul.  The story from the AP said this:

RON PAUL: “We have dumped the debt on the American people through TARP funding as well as the Federal Reserve. So the debt is dumped onto people. And what did we do? We bailed out the people that were benefiting during the formation of the bubble. So as long as we do that, we’re not going to have economic growth.”
THE FACTS: The $700 billion Troubled Asset Relief Program was proposed by President George W. Bush and passed by Congress in 2008 to help rescue banks and other imperiled financial institutions. Nearly all of the money has been paid back, with interest.
Most economists credit the program with keeping the financial system from freezing up and helping to prevent the worst recession in 30 years from becoming another Great Depression. The Federal Reserve does not operate on taxpayer money and does not receive any operating funds from the Treasury. In fact, it makes money every year from its banking operations, and turns over profits to the Treasury.

There are so many things wrong with these two paragraphs labeled “THE FACTS”, that it is hard to know where to begin.

First, the AP is saying that nearly all of the money has been paid back with interest.  But it is hard to know all of the facts because the Federal Reserve system and the bailouts are so secretive.  However, it is fairly well known that the Fed exchanged U.S. treasuries for a bunch of junk assets in the form of mortgage-backed securities.  So the government bought these bad assets at full price from the financial institutions.  Were all of these bad assets sold back to the institutions?  I don’t think so.

Let’s say I bought a bunch of shares of a stock for $50 per share and the price of the stock then fell to just $10 per share.  Then the Fed comes along and buys those shares from me and pretends they are still worth $50 per share.  So I get my $50 per share.  Meanwhile, I also take a loan from the Fed and pay it back with interest (at a very low rate).  Should we all boast about how the Fed was brilliant and how it didn’t cost taxpayers anything?

These banks got bailed out.  It wasn’t just loans, although that would have been bad enough.  Without the backing of the Fed, these banks and other institutions would have gone bust.

One thing that the writers of this story fail to understand is that even if the Fed had just loaned out money and all of the money had been paid back, it would still be harmful to the economy.  First, it is propping up the bad companies and the bad debt.  If every company in America is bailed out that is on the verge of bankruptcy, then we will soon be a very poor country.  There is no incentive to perform well and please customers.  Money is constantly being allocated to inefficient firms.

Another thing that the writers don’t understand is that by diverting funds to these failing businesses, it is preventing other individuals and companies from using this capital in a better way.  This is what Bastiat and Hazlitt taught.  You have to look at the unseen consequences.  By diverting hundreds of billions of dollars in capital, there are many businesses and products that would have been developed but which we will never know about.

In the last part of the AP’s story on Ron Paul, it says that the Fed does not operate on taxpayer money and does not receive any operating funds from the Treasury.  Yeah, no kidding Einsteins.  The Fed has a legal monopoly to create new money out of thin air.  Why would it need to collect directly from the taxpayers when it can just create whatever it needs?

Give me a legal monopoly to print money and I will be very profitable too.  I will fund my own operations and remit money back to the Treasury each year.  These writers are absolute geniuses.

In conclusion, the biggest part of the Fed bailout was buying up all of the toxic assets and paying the original full values.  This is highly inflationary in the long run because the Fed cannot sell them on the open market for anywhere close to what was paid for them.

It may be technically correct to say that the bailouts didn’t actually cost taxpayers.  It cost everyone who holds dollars (which is most taxpayers).  The TARP bailouts were inflationary and we will continue to see the effects, even if they can’t be seen directly.