( – promoted by buhdydharma )
Once again, the Federal Reserve is going to come to the rescue of Wall Street. Once again, it will be in the name of helping out “us”.
The idea behind giving the banks cheap money was that the banks would lend it to consumers and businesses. Unfortunately, that hasn’t happened: Since the start of the crisis, bank lending has fallen off a cliff. The banks are, however, lending to the Federal government, which needs to fund record deficits by borrowing more than $1 trillion a year. The combination of the Fed’s desire to stimulate lending via cheap money and the government’s desire to stimulate the economy by running a huge deficit has made it a great time to be a bank: Banks can borrow from the government at artificially cheap rates and then lend the money back to the Federal government at higher rates, pocketing the difference.
And now it’s going to get even better to be a bank.
As part of being in the Federal Reserve system, banks are required to keep a certain amount of money in cash at the Federal Reserve. The banks have always viewed this as a “tax”, because the money didn’t earn any interest and thus got no return.
When the crisis hit in 2008, the Federal Reserve started giving the banks a modest amount of interest (0.25%) on their holdings at the Fed. The banks, looking to bolster their reserves to cover their massive losses in the real estate market, flooded the Fed with cash. The Fed was busy using its cash to purchase worthless mortgage-backed securities from the Wall Street banks at face value.
Now the Fed wants to shrink the monetary supply. Normally the Fed would do this buy selling off its assets. However, unlike through most of the Fed’s history, its assets are illiquid. They are no longer flush with liquid Treasury bonds. Now they have hundreds of billions of illiquid mortgage-backed securities on their books that they can’t sell without a) taking a huge loss that they don’t want to admit, and b) forcing mortgage rates up, which would cause a second leg down in the housing market.
So how can the Fed shrink the monetary supply, and thus reduce inflationary pressure, without crashing the mortgage market and the banking sector with it?
By doing another bailout!
The Fed’s exit plan will call for increasing this interest rate, to encourage the banks to keep more money in excess reserves instead of lending it into to the economy and thus expanding the money supply.
The idea here is that, by increasing the amount of money on account at the Fed, the Fed will reduce the amount of money that gets loaned out to businesses and consumers, thus forestalling inflation.
Of course, in the process of increasing interest paid on reserves, the Fed will be paying banks even more not to lend. In the process, it will be giving banks yet another way to take nearly free money from the taxpayer and give it back to the government at a higher rate–and then pocket the difference.
To summarize: we bailed out the Wall Street banks so that they could get the credit markets working, and restart lending on Main Street.
Now we are going to bail out the banks yet again, but this time it is because we want to reward the banks for not lending to Main Street.
This is insanity in its highest form.