Do you remember that scene in the film Casablanca when the supposedly unsentimental Rick fixed his roulette wheel so that a young Bulgarian refugee couple could get enough money to buy an exit visa without the wife having to sleep with the lascivious Captain Renault? Well, papers recently obtained by Congress (through subpoena) show that much the same thing happened with our biggest banks during the financial crisis of 2009.
After the subprime mortgage bubble burst banks were left holding trillions in depleted or worthless investments. Their capital structures were shaky. Some went bankrupt, others teetered on the brink. Plaintive wails came from bankers seeking government intervention. In response, the government decided to preserve the existing financial system pretty much as it was.
Some institutions were permitted to fail; some were merged into larger entities; some were nationalized briefly. But the essence of both the Bush and Obama rescue programs was to declare most of the largest banks "Too Big To Fail." One tactic to stave off failure was to grant the "Too Big To Fail" banks the ability to accumulate enormous risk-free profits in order to rebuild their capital bases. The fixed roulette wheel worked this way.
The Federal Reserve kept short-term interest rates close to zero. Thus, selected banks could borrow short-term money from the government at minimal cost. They were then allowed to use these funds to buy U.S. Treasury bonds from the government, which carried yields of 3 percent to 4 percent. The resultant spread generated billions in risk-free profits subsidized, like the bailouts, by you and me. By the way, these profits served as the basis for huge bonuses paid out to executives.
Without disclosing the program's nature to the public, the Treasury and the Federal Reserve carefully calculated how much each new capital each "Too Big To Fail" bank would need to survive (like Rick and the Bulgarian couple). Then, like Rick, they let the game go on until that amount had been accumulated. In fact, buried deep in the Treasury's 2009 Stress Test report was a prediction of each big bank's profits. Of course, those predictions proved to be accurate because the game had been rigged to produce them.
The only honest statement to emerge from this sordid affair was made by Treasury Secretary Timothy Geithner in 2010: "We saved the economy, but we kind of lost the public doing it." As a taxpayer, researching this story made me feel like the croupier in Rick's Casablanca casino. After the Bulgarians left, he was asked by his boss how much money he had. "Less than I had a few minutes ago” was his reply.