David R. Henderson  

The Fed's Secret Handout

Shock Me, Shock Me... Voter Irrationality in Anim...

Remember when Ron Paul was almost the only politician in Washington calling for auditing the Fed? After this latest revelation, one can see what good sense he had in doing so.

Co-blogger Arnold Kling has already highlighted this, but it didn't attract many comments. But this has to be one of the scandals of the decade. Here's one excerpt from the Bloomberg story:

The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he "wasn't aware of the magnitude." It dwarfed the Treasury Department's better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.

The Fed didn't tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn't mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed's below-market rates, Bloomberg Markets magazine reports in its January issue.

Once again, comedian Jon Stewart does a better job of this than most of the mainstream media.

HT to Jeff Hummel.

Update: My original post above was misleading. This post by Felix Salmon explains why. HT to commenter Parag.

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CATEGORIES: Monetary Policy

COMMENTS (14 to date)
Publus The Lesser writes:

Some things that are not clear to me from the article:

(1) How much of the money lent by the Fed has been repaid and how much is still outstanding?

(2) How long were the terms of the loans? Was the fed loaning banks billions of dollars to be repaid the next day, the next week, the next month, the next year, whenever? Loans for very short terms sound like temporary liquidity injections to stabilize the system, while longer-term loans sound like capital injections to prop up broke banks.

(3) Is this still ongoing, and to what extent?

Ryan writes:

So, then, can we please do away with the TARP slogan -- "One of the most hated, but successful USG programs."?

Or am I missing the successful part?

Keep up the good work David.

Jason writes:

The interest rates on short term treasuries were zero at the time. The "profits" to the banks came from maturity transformation, not below market interest rates. This is what banks do, borrow short and lend long. Its no where close to risk free profit.

david stinson writes:

I'm thinking that doesn't quite align with Bagehot's dictum of providing liquidity at a penalty rate.

David R. Henderson writes:

Interesting point. Can you give a cite on this?

Jon writes:

The 7.7T number is deeply misleading. The highest amount outstanding at any one time was 460B. This number was published in the monthly H.3 reports. The only new information was how much was lent to each institution--not the size of the progam.

The real scandal here is that Bloomberg would goose the drama of an article by summing over the total lent to all institutions over the life of the program and insinuate that the program was larger than TARP when it was actually half the size.

Silas Barta writes:

@Jason: If the banks were borrowing at market rates, why couldn't they get those rates on the, er, market?

Because they were a lot riskier than Treasurys, the market rate for them was much higher. Yet they were able to borrow as if they were the safest possible investment.

Why not allow everyone to borrow from the Fed at 0%?

Jason writes:

The article states that the 13 billion figure is calculated by multiplying the net interest margin (interest on assets minus interest on liabilities) times the amount of borrowing from the Fed, and also argues that the banks used the loans to avoid selling long term assets. I put the pieces of the puzzle together for my earlier post.

Banks serve a valid role in the economy and a lender of last resort provision can be a good idea. People in the economy want to invest in long-term projects while borrowers want liquidity in their deposits. The banking system allows both to exist at the same time. The shadow banking system wasn't exactly the same, but this liquidity provision and maturity transformation is a very fundamental part of shadow banking as well. Banks are different than a lot of other institutions because most companies don't have situations where they are solvent but not liquid.

Just as when there is a run on conventional banks, we recognize that shadow banks may be solvent but not liquid when everyone wants to withdraw their short term loans to these shadow banks. The Fed seems to just be acting as a lender of last resort here to maintain liquidity.

The correct calculation for how much the subsidy was would have been difference between the cost of borrowing on the market and the Fed times the amount borrowed. This is probably very small relative to the question of whether this prevented the recession from being much worse (same can be said for the 13 billion number).

Shayne Cook writes:


A common defective perspective that is the basis of the Bloomberg article, Arnold's post, as well as Bagehot, Friedman, all macroecon textbooks, and a variety of politicians criticizing Bernanke and the Fed, is that a national currency (such as the U.S. dollar) is only fully relevant within that nation's borders.

That is NOT the case with the U.S. dollar at the present time - it is the global reserve currency. The U.S. dollar is the global reserve AND the primary denomination for all commodities traded on all global markets - at a time when over half the world's population is either at or achieving "middle class" economic standard. That combination has never happened to any currency ever in human history until now.

Bernanke and the Fed are managing a de-facto global currency, not just a U.S. national currency. And it's a vastly more dynamic task than existing macro or monetarist theory, or journalist/politician rantings envision. Those eager to criticize Bernanke and the Fed might be well served to expand their perspective to the global dynamic, before speaking and writing.

Having said that, Bernanke and the Fed may well be making serious errors. Again, there is no theoretical or historical basis for comparison under these circumstances. But the mere fact of money creation/policy beyond what would seem appropriate for just the U.S. economy at the present time does not indicate any error.

In Arnold's post, he asks the question of whether current Fed policy "serves the 99 percent [of Americans]". I would answer "YES", if for no other reason than the U.S. dollar status as a global reserve and de-facto global currency reduces transaction costs for all U.S. citizens.

But I would pose a question of my own:
Would anyone in their right mind actually prefer monetary policy be dictated by Barney Frank, or John Bohner, or Nancy Pelosi, or Barack Obama - or perhaps the "Super-Committee"?

Good luck with that.

rpl writes:
Would anyone in their right mind actually prefer monetary policy be dictated by Barney Frank, or John Bohner, or Nancy Pelosi, or Barack Obama - or perhaps the "Super-Committee"?
I've been wondering the same thing. All these calls for "accountability" seem to assume Congress as the entity to which the Fed would be accountable. Congress isn't exactly known for its sober and thoughtful decision making. In fact, all the available evidence suggests that if they had more direct control over the Fed, they would just play politics with it, the way they do with every other bit of business that comes before them. We're in a deep enough hole as it is; the last thing we need is for monetary policy to become a bargaining chip in health care reform, or abortion, or whatever it is that politicians have got their shorts in a twist over this week.
Silas Barta writes:

@Jason: I'm sorry, I don't follow. Was your last a reply to me? And if so, where do you explain why the banks shouldn't have been charged a penalty rate to discourage this reliance?

Jason writes:


We both agree that a penalty rate would discourage this reliance. We don't agree that discouraging the behavior is a good idea. There are times when the Fed should make dramatic moves to increase liquidity and avoid a deeper crisis.

Kevin writes:

David you might want to read the Fed's response and the pathetic backpedaling Bloomberg did in its response to the Fed's response.


Parag writes:

Felix Salmon's take is probably the most enlightening in this context. http://blogs.reuters.com/felix-salmon/2011/12/07/smackdown-of-the-day-bloomberg-vs-the-fed/ Bloomberg published a highly misleading report, but the Fed's lack of transparency makes it an easy target.

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