The government’s bailout and stimulus funds are beginning to pay off, with new reports surfacing this week that taxpayers are set to profit billions of dollars from their investments in financial  institutions and the mortgage securitization industry. The US Treasury Department expects profits of at least $19bn from bank investment programs under the Troubled Asset Relief Program (TARP), according to market commentary Wednesday by the American Bankers Association (ABA). Originally projected to cost $76bn according to the ABA, the outlook for TARP bank programs was updated in December in anticipation of actual profits. ABA noted the government already earned a “significant” average 14% on TARP investments that have been repaid so far. The Treasury has earned $15bn – $10.9bn in interest in dividends on $247bn of investments in 700 banks, plus $4bn from warrant repurchases and auctions – and expects profits of at least $19bn over the long term. The Treasury will also soon be receiving returns on taxpayer investments from Federal Reserve banks that made more than $46bn in 2009 on securities obtained through bailout and stabilization efforts. According to a statement Tuesday, Reserve Banks gained an estimated $52.1bn of net income for the year – driven primarily by earnings on securities holdings. The high earnings allowed the Federal Reserve [headquarters pictured above] to return billions of taxpayer dollars to the Treasury. “The significant increase in earnings on securities was primarily due to increased securities holdings as a result of the Federal Reserve’s response to the severe economic downturn,” the Fed said. After the Reserve Banks paid dividends to member banks and a contribution to a capital surplus, the Fed paid a total $46.1bn – the same as the earnings gained on securities holdings – to the Treasury, as required by federal policy. The year’s $46.1bn of net earnings include $5.5bn from consolidated limited liability companies, and billions more from debt securities and mortgage-backed securities (MBS) the Fed bought from government-sponsored enterprises (GSEs) this year. According to weekly analysis by Barclays Captial (BarCap), the Fed as of Jan. 7, 2010 bought up $1.12trn of mortgage-backed securities (MBS) from Freddie Mac (FRE), Fannie Mae (FNM) and Ginnie Mae. The purchase program bears buying power of up to $1.25trn. The Fed plans to wind-down purchases by the end of Q110. The Fed’s approaching exit from the purchases is making investors nervous. The winding down efforts are intended to prepare private investors to return to a leading demand role. Charles Plosser, president and CEO of the Federal Reserve Bank of Philadelphia, said in a speech Tuesday (available to download here) the Fed’s purchase program is “perhaps crowding out many private purchasers.” Plosser adds: “I believe it is important that we … reduce our participation in this market, so the private market can once again resume a significant role. It cannot do so as long as the Fed is the dominant player and we would risk delaying the return to normal market functioning rather than promoting that return were our sizable purchases to continue.” The Fed has considered extending and expanding asset-purchase programs, including the MBS program, if its exit this quarter is not replaced with private investor demand, causing MBS spreads to treasuries to blow out again. Global financial services firm Credit Suisse has projected spreads will keep tight or perhaps tighten further in the near-term as the Fed stages its exit, but investors remain nervous. HousingWire‘s Linda Lowell maintains the Fed’s significant demand held mortgage spreads near historic tights for months. On the other hand, a recent working paper from the National Bureau of Economic Research points out that demand generated by the Fed’s purchases is not enough to account for tightened spreads, due to simultaneous changes in prepayment and default risks. Write to Diana Golobay. The author holds no relevant investment positions.