Media stressing impact on taxpayers in AIG rescue

There was an interesting blog post yesterday, The Fed AIG loan and takeover – they’re getting it wrong!, about how people are saying how the AIG rescue hurts taxpayers.  The fact is that the Fed already holds cash reserves that are used for ensuring the functioning of the banking system.  I, myself, fell into the trap in my previous by referring so much to the impact on taxpayers.  The impact to taxpayer comes in when the Treasury issues more bonds to make sure that the Fed’s cash reserves are not depleted.  These bonds are paid by future generations with interest.  However, the Fed will be getting a higher return with this bailout.

CNN senior business correspondent Ali Velshi explains it best,

“The Federal Reserve keeps a lot of money in supply to help banks, and basically, when they help them, it means they loan them money. As this credit crisis intensified, the Fed invited more and more banks to come and borrow from it and would accept collateral that was not as high-quality as it would typically accept. The Fed was the lender of last resort for a bank; you paid a premium to borrow money from the Fed, and you had to give them your best collateral.

What’s happening now is you still pay a premium, but you can go with lower collateral. The thinking behind that is the more banks feel free to go to the Fed to borrow money, the less likely they are to get money at higher interest from other sources and the less likely they are to fail as a result. In other words, if they feel that there is an ability to borrow money from the Fed — if they absolutely have to to stay afloat — that facility is there.

Well, the number of banks that have taken advantage of this has caused the reserve at the Federal Reserve to go from about $800 billion to, by some estimates, as low as $200 billion. And when they do things like the bailout of AIG, that’s where that money comes from.

So you do the math, and there’s some sense that the Fed could run out of money to finance these banks, to give loans. And just the idea that the Fed could run out of that money causes Wall Street to panic because it says, “If four more banks were to fail, the Fed wouldn’t have money to bail them out, so we’re in a bad situation.”

So the thinking is: Let’s increase the Federal Reserve’s reserve, and that’s what this auction is. It’s the first in a series of auctions — this one will be for $40 billion — where the Treasury on behalf of the Federal Reserve issues bonds that they will sell at auction, the way they normally do, and they’ll be for 35-day periods. So the Fed gives out those bonds, and in exchange, gets cash and the Fed sits on that cash and uses it for whatever it needs.”    CNN