>I agree - I didn't explain this very well. The former utilizes taxpayer money, the latter doesn't. The first is an all-out investment, the second, a loan.
The Fed's loans are backed by taxpayer money, right? (Or by its ability to print money, which is a stealth tax on everyone who holds dollars). Put it another way, it's giving these companies for free something (a loan on generous terms) that would be worth quite a bit on the open market, and that belongs to us.
>The Fed has a mandate to ensure financial stability by providing such a loan facility (why it didn't do so for Lehman - and whether it neglected its duty - is still a very controversial topic) - so I wouldn't consider a statutory duty to be a discretionary bailout.
That sounds to me like there is a statutory requirement for the Fed to perform bailouts under certain circumstances. It doesn't make them any less of a bailout.
No - Fed loans are not backed by taxpayer money - they are backed by the faith in Fed to replace those dollars with assets of equivalent value. And no, it's not a stealth tax on anyone who holds dollars. The popular view is that ok, the supply of dollars has gone up and hence the money I hold is worth less.
But remember, all the MBSes in the pre-crisis market, they were liquid instruments being used as money by the industry. Suddenly that pool dries up. The Fed's job then was to keep that pool constant (the M0, M1, M2 and M3 supplies go up - but then MBSes and commercial paper are not included in any of those measures).
It's not a bailout in the manner of a Treasury bailout of Freddie Mac/Fannie Mae. First of all, it's not your (ie the taxpayer's) money to begin with. You have no right to be concerned about money that doesn't belong to you. Secondly, say I "bailed" out a company by taking an equity stake and the Fed loaned the same company some money. If the company goes bankrupt - I should have zero expectations of recovering my money. The Fed, on the other hand, would have first dibs on the recovery value of the assets.
>But remember, all the MBSes in the pre-crisis market, they were liquid instruments being used as money by the industry. Suddenly that pool dries up. The Fed's job then was to keep that pool constant (the M0, M1, M2 and M3 supplies go up - but then MBSes and commercial paper are not included in any of those measures).
So it's OK for the fed to devalue my dollars because other market events have increased the value of my dollars? If I chose to hold dollars rather than the MBSes that other people were treating as dollar-equivalent, and the value of MBSes goes down, I've earned that increase in value. Imagine I'd bought shares in a company, and then shares in that company become scarce due to market events (maybe there's a takeover bid) - I'd have every right to be pissed if that company then issued more shares to someone else, to keep the supply constant.
If the feds bust someone with 6 million counterfeit dollars, do they then immediately print 6 million real dollars to keep the money supply constant? That sounds like what you're advocating.
But you did earn that increase in value. A home you couldn't afford in 2006 because it cost $300,000 is now affordable at $175,000. The purchasing power of your dollars did go up (actually it didn't "go up" - it is reaching it's fair value - earlier your purchasing power was less). What the Fed did wrong was it didn't stop your purchasing power from decreasing back in the 2002-2006 era because it thought home-based credit supply would support the decrease in your income-based purchasing power (they never knew how interconnected banks with high leverage would soon destroy that fantasy - although they should have known.)
What the Fed tried to do after the crisis was to avoid deflation (which is as bad and as self-fulfilling a prophecy as inflation). Say I am a highly creditworthy homebuyer. If I had $175,000 (continuing with the example above) in my bank account, I would buy that house right out of the market. But most people don't make a downpayment of 100% (liquidity is precious to everyone).
I would take out a 30-yr mortgage at, say, 5%. Say, home prices are falling every year by 2%. So, if I make a purchase now - I end up paying 7% - 5% interest and a 2% loss in my home's value - that's the concept of a a real interest rate = (nominal rate - inflation), deflation being negative inflation). Now I am not protected by this capital destruction from my bank (they aren't paying me 7% on my equivalent-term deposits - they would be paying me something like 5% - similar to what I am paying for the mortgage).
So I would delay my home-purchase. That causes a further fall in home prices and so on - a deflation death spiral (something which happened in the 30's). As a corollary, in an inflationary scenario, people bring their purchasing decision forward ("it's cheap now, it'll be expensive later") which causes a rise in asset prices - which is again bad if not controlled (we know what happened, right?).
What would break this loop, though? Well, if the mortgage rate went down to 3%. That's exactly what the Fed did in QE1 (and in part, in QE2 and Operation Twist) - it stepped in to buy long-tenor MBSes directly, inflating their price and lowering their yield - causing mortgage rates to fall. Now you'd say, wouldn't depo-rates fall as well to 3%. Yes, they would - but they are more "sticky" than mortgage rates. That delay in money-market/depo-rate cut allows asset prices to recover - opening up non-money market avanues for investment - bonds/stocks etc. Also, the economy's "natural" growth-rate gets a chance to show its effect (which in the US's case was led by the tech and manufacturing sector).
There's another reason mortgage rates couldn't go down - the whole US MBS system is screwed up with stupid servicing, refinancing and foreclosure mechanisms - making it difficult to assess true recovery in case of default. While the government and the legislature kept on debating about HARP/HAMP/TARP/ARRA what-not, this deflationary spiral had to be stopped - the Fed did so. To get an idea of how a non-Freddie/Fannie system can work, look at the world's second largest MBS market - Denmark - not a single MBS default in 200 years! - http://www.coveredbondinvestor.com/sites/default/files/Danis...
The Fed's loans are backed by taxpayer money, right? (Or by its ability to print money, which is a stealth tax on everyone who holds dollars). Put it another way, it's giving these companies for free something (a loan on generous terms) that would be worth quite a bit on the open market, and that belongs to us.
>The Fed has a mandate to ensure financial stability by providing such a loan facility (why it didn't do so for Lehman - and whether it neglected its duty - is still a very controversial topic) - so I wouldn't consider a statutory duty to be a discretionary bailout.
That sounds to me like there is a statutory requirement for the Fed to perform bailouts under certain circumstances. It doesn't make them any less of a bailout.