A GOVERNMENT IN ACTION, MONETIZING DEBT

In early June 2009, Treasury Secretary Tim Geithner traveled to China, presumably to talk about US treasury bonds with the Chinese, who grew weary of the excessive debt that the US had put on.  In an interview with CNBC’s Steve Leisman, Geithner was asked if he believed that the United States was monetizing debt, which the Federal Reserve buys US Treasuries from the government in exchange for cash. 

LIESMAN:  Why are you saying-- I mean, you're saying that buying $300 billion of debt by the Fed is not monetizing?

GEITHNER:  Absolutely not.  Again-- the-- no conflict between the Fed's responsibilities for a financial stability, the measures they've taken to help make sure that there's liquidity for markets.  We're (UNINTEL) this process of adjustment in the financial system and their long term obligation to help-- help keep inflation low and stable.  And I'm completely confident in their ability to do that.

So the Treasury Secretary is stating that the government is not creating money through its massive spending spree.

If that’s the case, how’s come according to the chart below, the money supply started popping when the bailouts began?

Money Supply in Billions, 2008-2009

It is becoming more apparent in the study of economics that if the money supply were to contract, an economic depression is imminent.  Notice the light decline in the money supply from July to August 2008.  It was clear based on this model and the bankruptcies that occurred in September that a depression was looming.  But, did we really need to print an extra trillion dollars over the next year?

If the federal government is not monetizing the debt, than where did all this extra money come from?  The Federal Reserve’s purchase of $300 billion in treasury debt last year was a transaction where the Fed gave the government $300 billion in exchange for debt.  How is that not debt monetization?

Furthermore, Wikipedia has a special section on monetizing debt where it solely singles out the United States: 

"In the United States, and in many other countries, the government does not have the power to issue new currency to pay its bills^{[citation needed]} – it must instead finance the deficit by issuing new bonds and selling them to the public to acquire the necessary money to pay its bills. However, if these bonds do not end up in the hands of the public, the only alternative is for them to be purchased by the central bank. For the bonds not to end up in the public hands the central bank must conduct an open market purchase. This action by the central bank increases the monetary base through the money creation process. This process of financing government spending is called monetizing the debt.^[1] Monetizing debt is a two step process where the government issues debt to finance its spending, the central bank purchases the debt from the public and the public is left with high powered money."

So, we may want to ask Treasury Secretary Geithner again whether or not we are monetizing the debt.  I just hope he didn’t try to tell the Chinese we weren’t.  If he did, he would have made us all look dumb.

OBAMA’S ‘SPENDING FREEZE’ DOES NOT MEAN SPENDING REDUCTION

OBAMA’S ‘SPENDING FREEZE’ DOES NOT MEAN SPENDING REDUCTION

Recently, President Obama touted a spending freeze targeted at reducing the budget deficit. In the State of the Union, (which is referenced in the below video) Obama said that defense spending, Medicaid, Medicare, and Social Security would not be affected by these freezes. Later in the same speech, the President stated that Medicare, Medicaid, and Social Security costs were going to soar.

So, let’s use the White House’s own projected budget numbers to show how this “freeze” is totally irrelevant to spending.

2009 estimates show that Medicaid ($353 Billion), Medicare ($431 Billion), Social Security ($680 Billion), and Defense ($690 Billion) total $2.154 trillion out of a $4.0 trillion spending spree. These areas account for nearly 54 percent of all spending.

On top of that, other areas of the government are going to see HUGE increases in spending in 2010. International affairs is going from $34 to $50 billion, energy is going from $8 to $22 Billion, transportation from $92 to $106 billion (up from $77 billion in ’08), education from $79 billion to $134 billion, income security from $519 to $547 billion (from about $300 billion in ’08), and interest on the debt is going to go from $150 billion in 2009 to $400 billion by 2013.

So when the President says the government is tightening its belt, he means they will double their waist size then tighten their belt.

In fact, according to the White House budget estimates, the spending will be back at $4 trillion by 2014. That means the hundreds of billions gone from TARP and bailouts will be placed by other areas of fiscal inflation. So where is most of that money going? The answer appears to be social programs and the interest on the federal debt.



Looks like we can chalk up another victory for Lyndon Johnson and the Great Society!
Do you think the above numbers reflect an increase or decrease in the number of people on government programs?

The AIG Screw Up

THE AIG SCREW UP

I have been following the AIG crisis since day one, when Lehman Brothers fell, and I never expected this bailout to be going this bad this soon. However, once again, the federal government has exemplified why it should not cross the boundary into corporate financing and ownership. While the administration is touting that the banks paid back TARP (enough to punish them with a tax), they are hoping to overlook the error of AIG which will cost the taxpayer 10-fold to any TARP profits.

History

In case you fell asleep in August 2008 and just woke up, here is a brief history of the AIG crisis.

AIG made billions on credit default swaps, which basically was insurance against investments. An investor who bought stocks, bonds, or another type of assets could “insure” those investments so that if they failed, the investor could get some of his/her money back. In Sept 2008, Fannie, Freddie, and Lehman collapsed in less than two weeks throwing hundreds of billions into default. Investors who were wiped out began clamoring on the door of AIG for their insurance payouts. AIG, which itself lost money from the collapses of the institutions, found itself short on cash with $30, $45, $60, then $80 billion in immediate liabilities and growing by the hour.

As I recall, AIG was originally bailed out for $85 billion. Somehow, this number ended up swelling to close to $200 billion as more defaults on mortgage-backed securities and more investors came to AIG looking to cash their insurance policies. Analysts and others have argued that had AIG not been bailed out, a wave of bankruptcies would have swallowed the global financial markets.

A Long Line of Errors

First, the government bailed out AIG without any concessions from the struggling insurer. No bonuses were eliminated, no timelines or deadlines were set, no individuals were designated as accountable for certain tasks, and what’s worse- the bailout money was not earmarked, meaning that it could be used for anything.

Next, along the lines from above, AIG paid out it’s creditors at 100 cents on the dollar or 100% of what was owed. There were no negotiations with these creditors, no analysis, assessments, nothing. AIG just asked for X amount of dollars from the feds, got it, and paid off its debt in full. Why? I believe it is because it is easier to spend other peoples’ money. I tried to find another case where such a debt was settled at 100 cents on the dollar and could not find one.

It gets worse.

According to this Wall Street Journal article, $50 billion of the $180 billion went to European debtors. So now, US taxpayers are bailing out European firms as well as American firms? Why wasn’t any of this researched or disclosed PRIOR to the bailout? Reports suggest that as much as $90 Billion may have went overseas from the AIG bailout. Why don’t we have exact numbers? To add insult to injury, regulators will not disclose who AIG’s counterparties (party to the contract) are.

So, what would have happened if rational-minded individuals would have taken a step back to determine whether AIG should have been bailed out?

1) $50 to $90 billion would have been taken off the bill, since it was owed to foreign entities. Let European Central Banks bail out their own, we have enough problems here and we surely would not have expected another country’s central bank to come to our aid.

2) An additional $20 Billion could have been cut off the bill as New York’s governor allowed AIG subsidiaries to lend to AIG right before the bailout. Research on the matter of whether or not this money was lent have found no results including this statement from the Federal Reserve Vice Chairman which mentions “subsidiaries” multiple times but no disclosure of lending outside of that of the federal government. In fact, the report hints that AIG used bailout money to pay off its debts to its subsidiaries, something that was not necessary.

3) Assets in Exchange for Debts. AIG could have directly transferred performing assets over to their creditors in exchange for a debt write-down. Although highly unusual, such a transfer could have been backed with the threat of bankruptcy had the counter-parties not agreed. In the midst of the crisis, the Wall Street Journal reported:

“AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are "fully capable of meeting their obligations to policyholders." AIG said it was trying to "increase short-term liquidity in the parent company," but said that didn't "include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity." Asia is one of AIG's largest markets.”

So if we take $70 billion off the government bailout plus add the assets for debt forgiveness program (at LESS than 100 cents on the dollar), maybe we buy a good amount of time where the company would have the opportunity to fix itself, and buy time for the government to develop a lending plan. I’m not advocating that nothing be done, but as Rick Santelli stated, “just because we can’t do nothing doesn’t mean we had to do everything.”