Reverse Bank Robbery

Most of us work for a living, the rest are bankers. These days the news is filled with great tales about how America's banks are coming back.

Even that giant corpse Citigroup
is showing signs of life. Its stock is now selling for more than five
times the lows it hit earlier this year. Its market capitalization is
up near $57bn, a bit more than the $45 billion that the government lent
them through the Troubled Assets Relief Program, or Tarp. Some are even expecting that the government will make a profit on its Citigroup investment.

These
hopes are probably somewhat premature. Citigroup still has many bad
assets on its books which it has not yet written down. Furthermore, the
government is directly on the hook for $300bn of these bad assets,
having offered a guarantee as part of its "December Citigroup Rescue
Special".

In this case, Citigroup may be able to prevent losses
and boost the value of its government-owned stock because the
government is picking up its bad debts. This is a case of money going
into one pocket but out of the other one; that's not the way that most
investors make money.

In fact, much of the story of the return
of bank profitability has this character of money in one pocket and out
the other pocket. To make the story as simple as possible, banks can
now borrow money short-term at near zero cost from the US Federal
Reserve. The Fed has pushed rates to near zero in order to boost the
economy. On the other side, banks can buy up US government bonds that
are currently paying around 3.5% interest.

This means that we
lend the banks the money that they lend back to us, albeit at a
considerably higher interest rate. To take round numbers, let's say
that the banks have borrowed $1 trillion from the Fed's various lending
facilities. (The Fed's total loans are now over $2trn.) Suppose they
pay an average interest rate of 0.2% on this money. If the banks then
buy up government bonds that pay a 3.5% interest rate, they can pocket
the difference of 3.3 percentage points. On a trillion dollars of
lending, this will give the banks $33bn a year in net interest or
profit. This is the extra money that the government is paying the banks
to borrow back the money that it lent them through the Fed.

Of course this is not the whole story of the banks' return to profitability. We also have the shrewd traders like the Goldman Sachs crew.
They take the money that they borrowed, either directly from the
government or with the government's guarantee, and use it to speculate
in items like oil and other commodities.

These folks are
betting that they can outguess the markets. For example, the Goldman
boys might catch oil on the way up, so that consumers pay higher gas
prices somewhat sooner to cover Goldman's trading profits.
Alternatively, they might short a commodity like oil. This will cause
the price to drop more quickly than would otherwise be the case,
leaving producers with somewhat less money than if Goldman hadn't
stepped into the market.

In either case, Goldman's gains come
at the expense of other actors in the market. There is not anything
necessarily wrong with speculation; informed speculation can provide
useful information to the markets. However, in this case the taxpayers
are financing it, and taking the risk if it goes bad.

It turned
out Goldman's bets were winners in the second quarter, so this means
that the taxpayers paid for Goldman's profits with the higher gap
between the prices paid by gasoline buyers and other consumers and the
money received by oil companies and other producers. Of course, if
Goldman's bets had gone badly, taxpayers would have been forced to
cough up the money to make up the losses directly through the Treasury.
Either way, the taxpayers get to pay.

That is the basic story of
the banking industry. These folks have the system set up so that they
should be able to make money pretty much regardless of what happens,
with the risk of bad outcomes all placed on the taxpayers.

Many
people are outraged that the banks intend to pay their top executives
large bonuses. But these unthinking populists simply don't recognize
these people's extraordinary talent. After all, it is not everyone who
can get the government to subsidize them to the tune of several billion
dollars a year. These people may not fare very well in a market
economy, but these bank executives get huge rewards in an economy like
the one we have in the US.