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Financial bailout: as profitable as Google?

The Treasury predicts a fat payday from the Wall Street rescue โ€” thanks to a trillion dollar sleight of hand.

Despite that profit, banks still owe the Treasury $30 billion. By the time the program is completely unwound, the Congressional Budget Office estimates that taxpayers will come out $16 billion ahead from assisting some 707 financial institutions. (Forget too big to fail: TARP rescued such pillars of the American financial scene as SunTrust Banks, KeyCorp and Financial Institutions, Inc of Warsaw NY.)

This good news from banks is somewhat deceiving, however. Part of the reason that the sector has done so well is that the rescue plan includes major transfers — amounting to billions — from the government via AIG, which had insured large swaths of debt that the banks held. Normally, when receiving payouts from a bankrupt company like AIG, investors would expect to take “a haircut” — to receive only a portion of the money. Government-owned AIG, however, paid at full face value.

But TARP is only part of the bailout. In July 2008, Congress also authorized a rescue of Fannie Mae and Freddie Mac, the quasi-government mortgage investment houses. These institutions have sucked up about $140 billion, of which the Treasury estimates about half will be recovered.

These previous paragraphs add up to a lot of red ink — about $100 billion for Fannie, Freddie and TARP (including some smaller sums that we haven’t mentioned). So how does the Treasury foresee the bailouts earning a $24 billion profit?

That will come from a $110 billion credit that it cryptically calls “Federal Reserve Programs.”

Here’s how that Fed windfall works: Beginning in 2008, as the economy tanked, the Fed deployed its God-like central bank powers to create more than $2 trillion — merely by crediting its account with the money. It invested this newly minted cash hoping to prop up the economy, by creating demand for assets that everyone else was dumping, and by increasing liquidity (basically, making it easy for people to borrow by making money more plentiful). It purchased $1.25 trillion in mortgage backed securities — the same toxic assets that poisoned the financial system. It has also bought more than $1 trillion in U.S. government debt, and continues to do so.

The interest on these investments — which may in part come from the interest you pay for your mortgage — is throwing off good money: $82 billion in 2010 — which the Fed transfers to the Treasury. (Note: We explained the Fed’s powers, as well as the potential risks of using them, in a previous article.)

The money is real, even if it is created out of thin air.

The bottom line remains the same: The bailout medicine appears to have worked. The pain isn’t over yet, but it appears that we’ve averted an economic depression, and the cost to taxpayers looks poised to remain modest.

Still, TARP isn’t Google, nor is it something we ever want to even discuss again. If we had those many billions of dollars to invest in schools, transportation or energy independence, we’d be a stronger nation. So while the antidote appears to have been effective, and while we may not rue the day TARP was passed, it’s safe to go on hating the bailout.

Follow David Case on Twitter: @DavidCaseReport