When I heard the news that the Federal Reserve Bank of New York is making $85 billion available to American International Group in the form of loans, one of my first questions was about the source of the money. Does the Federal Reserve keep an emergency fund available to bail out companies during financial crises or does it just create the money out of thin air?
My question was answered on last night’s episode of Marketplace. Since the private sector refused to help AIG, the government stepped in to prevent financial meltdown. The $85 billion is taxpayers’ money, but it’s not funded by taxes we’ve paid. The U.S. Treasury Department sells securities to the public in order to raise the funds used for this bail-out. Yesterday, the Treasury Department auctioned short-term investments. The 35-Day Treasury Bill issued yesterday raised $40 billion in one day.
This auction process allows the investor to name their interest rates, and the Treasury picks the best offers. Many people were willing to lend the government money at a 0% interest rate. The median interest rate for all bids was 0.05%. The Federal Reserve, in turn, is lending money to AIG at a variable rate currently above 11%. If AIG is able to sell its assets and pay back the loans to the Federal Reserve over the next two years, the government stands to make a lot of money thanks to the wide spread in interest rates between the Federal Reserve’s borrowing and lending.
Even if AIG does not pay back the loan, the Treasury Department will still be able to pay back its investors. The government will use whatever means necessary in order to pay the investors as agreed, possibly printing money if necessary.
The fact that the government was able to raise a large amount of money at very low interest rates shows that investors are nervous. They’re willing to invest their money at a very low rate in return for a very safe investment.
Where does bailout money come from?, Marketplace, September 17, 2008
Treasury Auction Results (PDF), U.S. Treasury Department, September 17, 2008
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9:21 am (reply)
I guess those investors haven’t heard of FNBO 3.75% savings accounts!
1:52 pm (reply)
Banks like FNBO provide FDIC insurance only upto 100,000. So for any one wishing to get a insurance on their money this is the best way to protect their money. Think hedge funds or mutual funds.
5:40 pm (reply)
How is buying a bond with a 0% interest rate an investment? This sounds like a money laundering scheme.
7:33 pm (reply)
The article cited explains: “They were willing to lend the money to the Treasury for free, knowing that they wouldn’t lose it in the stock market or that they wouldn’t have it be held by another financial institution that could undergo some difficulties.” Its certainly odd but I guess there are some people out there that just want to make sure their money is SAFE for the next month. There may be more to the story than that and there could be other specific reasons it pays someone to have money safe for a month even at a 0% rate.
Jim
4:27 am (reply)
who are the bidders and buyers? Who has a lot of green backs? Chinese? But investing at 0% is lunatic! Factor in inflation and it is a NEGATIVE investment! Does the Treasury say who are the buyers?
9:52 am (reply)
lordbuddha: I don’t think the Treasury releases that information, but this explains why investors bid 0% on T-bills. I wouldn’t be surprised if many are international investors.
11:48 am (reply)
So, our international friends are doing us a favor by giving us money. Remember, there is no free lunch (by Milton Friedman?).
3:25 pm (reply)
Hey guys…how about that “printing more money” as the Plan B to pay off investors? Did any of you ever read about the inflation in Germany post WWI, when people literally were hauling money around in wheel barrows to buy staples?
You can’t keep devaluing the dollar forever and not pay for it eventually!
11:27 am (reply)
Valerie is spot on. The money is there, but it will be of lesser value. I would start investing in precious metals, other currencies, or equities in other countries by way of mutual funds or stocks.
1:34 am (reply)
Still looks a little dodgy to me. There must be some effects of valuation as compared to foreign currencies. For international investors to put money in at 0%, and risk inflation and currency risks looks a lot risky.
Even domestic investors would have to worry about inflation.
Maybe some answers will come out in a few years.