Balance-Sheet Accounting and the 2008 Rescue of Banks

a supplement to

Into the Heart of Darkness—of Money

Upstream to Its Source

by  Agent d’Amore

The 2008 bail-out was not what most people think.   Why?

The banks work within a system where if they get into trouble by being a little short of funds, they can go to the Federal Reserve Bank (the discount window) to borrow against some of their assets.   In the 2008 crisis aftermath, the Federal Reserve got very generous with the type and quality of assets they would take as collateral.   This includes the TARP program as well as the larger and longer-lasting QE (Quantitative Easing) program.   Essentially the Fed bought securities from banks and balanced the Fed’s balance sheet by crediting the accounts of the banks at the Fed.   They were buying about $80 billion a month of securities from banks.   The cost to the Fed to do this was a total of $0.

Bank balance-sheet accounting makes the 2008 rescue of banks and the Federal Reserve Bank’s subsequent “quantitative easing” program make sense to non-bankers.   The Fed, acting as the banker of last resort, bought debt securities from various banks at full face value.   The Fed added these securities received from the banks to the Fed’s balance sheet and accounted for the acquisition with a corresponding liability entry in the accounts of the banks that were “selling” the securities to the Fed.   The banks were happy to sell these securities at 100% of face value, because the market value (if they were to sell them to other banks or to private investors) was generally quite low (maybe 30% to 50% of face value).

What did the purchase of the approximately $85 Billion (per month over 2+ years) of these securities cost the Fed?

It cost the Fed $0, as the payments were just bookkeeping entries on the balance sheet of the Fed.   When the Fed went to unwind the program, the Fed was able to show a profit.   This was because the Fed sold the securities at market prices even though its cost basis was $0.   Therefore the entire sales price was profit.

While banks were enjoying this assistance in cleaning up their balance sheets by means of the Fed buying all their “junk”, there were those pundits decrying the Fed for creating tens of billions per month in new money.   These people were saying that creating all this new money would cause inflation.   The mistake they made (inflation did not appear!) was they did not realize the Fed was trying to counter the extreme deflation caused by so many loans going bad and essentially thereby destroying money.

The net result of the quantitative easing program was to flood the world with dollars (through the banks) at the exact time when there was a massive destruction of dollars globally.

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