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TAF was designed so that commercial banks could borrow from the Fed anonymously and avoid the negative stigma that came with publicly borrowing from the “discount window” (the Fed’s traditional source of credit for banks). This amounts to a tacit devaluing of truth in the marketplace, favoring asymmetric information that misdirects the use of capital (I'll leave that discussion for a separate article). Over a 27-month period ending in March of 2010, the Fed lent out $3.8 trillion through TAF. This money was spread out over 4,000 different loans, with terms ranging from 13 days to 85 days, and with most institutions borrowing more than once from the program.
For 85 percent of program, the Fed lent at rates below the “discount window primary rate”—the market measure for what banks would normally borrow. If the Fed were charging a penalty, it would be charging at least the primary rate plus an additional amount.
Contrary to Bernanke’s statement that most were charged a penalty rate, most were actually underpriced loans. The ultimate result was the Federal Reserve lending to unsound institutions, against poor collateral, and with no penalty—i.e., giving money away for free to the Fed’s closest friends.
The Fed effectively put aside any concerns for moral hazard with its actions, and instead focused on short-term aims over long-term negative consequences. The result has been an outrageous carry trade, with some financial institutions taking in virtually free money, buying Treasuries that yield about 3 percent (lending it back to the government that just gave it to them), and banking the difference. Bloomberg estimates that banks have made about $13 billion from this, which those banks have then used to pay large compensation packages.
Lending to everyone, accepting whatever is available as collateral, subsidizing the entire operation, and ensuring that financial players suffer no consequences for their own foolish actions is not the free market at work. When the Occupy Wall Street crowd complains about illicit gains, this is the source of their anger. We have a crony capitalist system and the government is doing everything in its power to avoid changing it.
Anthony Randazzo is director of economic research at the Reason Foundation.