Wednesday, November 26, 2008

Keeping Score on the Bailout

Sometimes, it's all one can do to just keep track of the money flowing out the doors of our federal government. Yesterday, the Federal Reserve announced it is buying $800 billion of mortgage debt and consumer loans. The New York Times has a summary of the bailout to date:
$1.7 trillion in loans
$3.0 trillion in investments
$3.1 trillion in guarantees
For those keeping score, that represents more than half of U.S. GDP.
Here are a couple of basic questions: How can the Federal Reserve just buy up another $800 billion in loans? And where does the money come from?
In terms of the federal government's balance sheet, a loan can be considered an asset, as long as there is a meaningful expectation that the loan will be repaid. The same can be said of loan guarantees, provided that the fees for the guarantee are sufficient to cover the risk. As for direct investment, the preferred shares and stack warrants also have value that could even provide a profit if the companies rebound.
But there are larger questions: Doesn't this money have to come from somewhere? Is the government just printing money? How does this enormous expansion of lending and investment affect the value of the dollar?
We all learned in economics class that printing more money is a recipe for inflation or a drop in the value of the currency. It has often been described as more dollars chasing a fixed set of goods and services.
There is no immediate prospect of inflation. Consumer prices fell 1.0% in October, 0.1% if energy prices are excluded--
the first monthly drop in core prices since 1982.
As for the drop in currency value, all of the major economic powers are pumping cash into their economies, so the dollar is unlikely to be singled out for punishment.

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