I’ve mentioned before that its hard to see how the Financial Sector is making money off the taxpayer from the various bailouts when you consider that the taxpayer is taking home a hefty profit.

I always felt that TARP gave the banks too generous of a deal, but that’s different than actually paying them taxpayer money. As I have said unpolitely in the past, when you have someone by the ball, you squeeze. That is to say – Garett Jones style concerns notwithstanding – I would have made every attempt to take the financial sector for everything it was worth.

Not that I have anything against them, but when there is money on the table its always better that you walk away with it than the other guys. If you want to throw him a bone later fine, but in the first showdown you take your counterpart for every single penny you can.

However, some people have still raise the issue of interest on reserves. Isn’t that a give away. Nope, its actually wildly profitable to the tune of $80 Billion a year currently.

Jim Hamilton explains

The Fed is currently paying banks 0.25% interest on those reserves, and is collecting an average interest rate of 4% on its long-term securities. That netted the Fed a healthy profit of $80 billion in 2010, which it returned to the U.S. Treasury. In effect, the Fed is borrowing short and lending long, making a huge profit on the difference, and handing it back to the Treasury.

Doesn’t the Fed face interest rate risk. I’ve always felt that looking at the numbers at the likely path of monetary policy the answer was no. On one level the Fed’s interest rate risk is simply self-imposed since it both controls monetary policy and as far as I know has no requirement to hold a positive capital balance.

That is if the Fed is at any point insolvent, then so what? Financial institutions go down not because they are insolvent but because they are illiquid. You can’t be illiquid when you have the printing press. You just hum along in insolvency making profit on normal operations until you recapitalize yourself.

Hamilton notes specifically that interest rates would have to rise to 7% before the Fed even started losing money and it has capital to burn.

A recent article by Glenn Rudebusch of the Federal Reserve Bank of San Francisco notes that the risk is substantially less than the simple “borrow short, lend long” interpretation might suggest. The reason is that $1 trillion of the Fed’s liabilities take the form of currency in circulation, which you can think of as funds the Fed has permanently “borrowed” at 0% interest. Rudebusch calculates that the interest rate on reserves would have to rise to 7% in order for the Fed not to earn a positive cash flow on its current portfolio, once you factor in the benefit to the Fed from the fact that a good fraction of its liabilities require no interest payments

Further, the fraction of liabilities as currency will presumably rise as time goes on, thus further insolating the Fed from interest rate risk.

There may be some way you can get out the notion that the financial sector is leeching off the rest of the tax payer but I just don’t see it. There are just enormous profits to be made in this sector and indeed the taxpayer is making many of them.

Why there are enormous profits is the question. Why doesn’t competition drive profits to zero?

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