Explaining the banking bailout

Karl Denninger walks skeptics through the application of TARP and explains in detail why TARP did not represent Washington imposing its will on Wall Street, but rather elite Wall Street bankers rescuing the big banks by utilizing the federal government as a tool:

You realize that what you feared – a call to announce that the regulators were seizing all of your firms as they all had no mathematical way to survive isn’t what was going to happen at all! Instead, you were going to be given some $250 billion between you and the FDIC was going to take all credit risk on your new bond issues for the next year. In addition you were briefed on the TLGP which will guarantee your customers won’t run your bank as it provides their demand accounts with unlimited FDIC insurance protection. This is to be “free” for the first 30 days, and after that there’d be a fee, but compared to trying to keep your deposits and issue cheap debt it was for all intents and purposes zero cost. Finally, Ben was going to let you have basically unlimited Fed credit at near-zero interest rates for the next year, meaning there would be no issue as to whether you could fund routine operations or not.

Your firm was being saved and the taxpayer was going to cover the risk – whether he liked it or not.

You were going to be asked to do a few things, however. The public would never sit for being looted like this unless it looked like it was going to hurt a lot and there was simply “no alternative.” As it was Treasury and Bernanke were not sure that the public would buy it. Congress already had bought off on it, effectively; after all, Ben and Hank had corralled them into a room and threatened them with martial law if they didn’t pass TARP to begin with. But it was important to make it look stringent, so there’d be no big bonuses until you paid the TARP money back and dividends would have to be cut to effectively zero.

All in you were getting a screaming deal. Not only are you getting cheap capital, all things considered (the 5% preferred coupon with that FDIC backstop when your CDS spreads are being quoted in points up front literally saves your firm!) but the FDIC insurance on both senior debt issues and deposits – that is a pure windfall of unbelievable size.

You roll the numbers around in your head. There is roughly $850 billion in deposits throughout the system that would be covered by the FDIC “unlimited” deposit insurance, and the majority of it was in your bank and that of your TBTF friends. You figure that you and your buddies in the room could issue some $300 billion in “super insured” debt through the FDIC program and the surcharge from the FDIC is only 50 to 100 basis points; with the credit condition oncoming long rates will be headed southbound fast, so the odds are you’d see a 10 year in the 2.5% or so area soon. That makes the deal damned attractive; you figure between you in the room this will easily save you $15 billion a year in the first-year financing costs (about 500 basis points on that $300 billion) or more than the coupon on the preferred stock!

It doesn’t take long before the light comes on – this is a zero-cost option for you. The capital costs a coupon on the preferred but the savings on the bond issues more than make up for it and the FDIC deposit insurance makes sure nobody runs your bank.

For all intents and purposes you’re being paid to take the taxpayer’s money!

When you walked in the room you were sure you were going to be nationalized – or at least expropriated in some fashion, as you were dead flat broke. Now, well, let’s just say that it’s good to have friends in high places.

You wonder how the press is going to spin this one. This finance stuff is pretty tough for mainstream reporters; so long as nobody noodles on the numbers they probably won’t figure it out. Never mind that the bonds won’t all issue at once and most people will simply applaud the unlimited deposit insurance without thinking about the fact that it’s essentially a gift – the 10 basis point fee (0.1%) is a bad joke. $8 billion across the entirety of the system to provide unlimited coverage on $800 billion in deposits? This much is certain: Nobody’s going to be allowed to fail as that’s wildly lower than the actual risk premium on that transaction.

What’s not to like?

TARP was one of the most egregious breaches of capitalism in the history of the United States and no one who defends it, for any reason, can be considered even remotely pro-capitalist. Corporatism is not capitalism and Wall Street banksterism of the sort we have endured for the last three years has far more in common with royal mercantilism than it does with capitalism.

Do read the whole thing. The chances are very high that you will not only learn something, but you will be able to understand what actually happened in the fall of 2008.