Lending Taxpayer Funds to Investment Banks and Hedge Funds is Suicidal for Taxpayers

Sankarshan Acharya
April 9, 2008

April 9, 2008

Senator Barack Obama           312 886 3514
Senator Charles E. Schumer    202 228 3027
Senator Chris Dodd                 860 258 6958, 202 224 1083
Senator Hillary Clinton            202 228 0282, 212 688 7444

Lending investment banks and hedge funds is financially suicidal for taxpayers.

Dear Honorable Senators,

Investment Banks (IBs) are highly leveraged entitles that borrow, mostly taxpayers’ funds, to trade to usurp savings of hardworking Americans. 

Commercial banks are also highly leveraged.  But they provide an immense service to society by taking short-term deposits and debts to lend long-term to homeowners for living and to corporations for job creation. 

If IBs and hedge funds (HFs) trade with their own money, then it should be their business.  But taxpayer funds should not be lent to IBs and HFs. 

Taxpayer funds come in two forms: insured funds in commercial banks and reserves at the Federal Reserve Board.  Lending such taxpayer funds to IBs is tantamount to financial suicide by taxpayers. 

Conscious taxpayers will never commit financial suicide by lending their funds to IBs and HFs.  It, therefore, behooves genuine representatives of taxpayers to vote against such lending of taxpayer funds to IBs and HFs.   

This also means that investment banking and commercial banking should never have been merged by repealing the Glass-Stegall Act. 

Just visualize that a bunch of IBs and HFs borrow taxpayers’ funds to trade securities held by taxpayers.  The gain from such trading is a loss to taxpayers.  After trading for such gains, if no further gains are feasible, some IBs and HFs will obviously collapse.  Their collapse is thus due to the fact that they could no longer squeeze or usurp taxpayers’ wealth.  It seems insane for taxpayers to bailout such collapsing IBs and HFs, let alone lend more of their funds to the remaining usurpers. 

Shouldn’t the taxpayers’ representatives act in the best interest of taxpayers while serving as the most respected lawmakers of the most important and responsible nation on earth?    

With profound regards,

Sankarshan Acharya

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Numerical Example:

In this example, the IBs borrow taxpayers’ money and sell securities held by taxpayers short; when the price of those securities drops as a result, the IBs make money by covering their positions as panicking taxpayers sell. 

  • Suppose taxpayers buy $1 worth of securities in mutual funds using their savings. 
  • The IBs sell those securities short with massive leverage with money borrowed from taxpayers over a period of, say, 4 months. 
  • Suppose that the price of those securities drops 50% to $0.5.  The mutual funds panic and sell at $.5 for a loss of $0.5. 
  • The IBs make $0.5, pay 3% interest for the days they borrowed the taxpayers’ funds and pay 30% tax on the gain. 
  • The government gains .3x.5 = .15 in tax. 
  • The interest cost to IBs is 0.01. 
  • Then the government in behalf of taxpayers gets 0.01 + 0.15 = 0.16 in interest and tax. 
  • The IBs make a net profit after taxes 0.5 - .16 = .34. 
  • The taxpayers (as mutual fund investors) lose 0.5, which is transferred to government in taxes and interest equal to 0.16 and to the IBs as net profit of .34.
  • The economy benefits little as a result of the game played by IBs. Eventually the taxpayers panic and the economy faces continual depression. Economic growth based on incomes hides the wealth transfer from the vast majority of taxpayers to a fringe. Lending taxpayers' money to IBs is thus suicidal for taxpayers. Short-selling is also suboptimal for society.