This is because: firstly, Banks increasingly do not have the regulatory capital available to support new lending; and; secondly, even if they have the capacity to lend they increasingly do not have confidence that their counterparties will be in any position to repay the principal, never mind the interest.
The only solution perhaps - and the Fed does have extraordinary powers do do so - is for the Fed to lend directly to borrowers at minimal rates. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
The only solution perhaps - and the Fed does have extraordinary powers do do so - is for the Fed to lend directly to borrowers at minimal rates.
In other words, make the banking sector redundant.
Except that it will not happen because the Fed is working for the banks and no one else. And the Fed is bailing the banks out by buying their rotten assets through the TAF.
Krugman has a pretty good post on the situation.
Quoteth Krugman quoting others:
Waldman calls the Fed "Wall Street's genial pawnbroker", and one of Yves Smith's commenters goes one better and calls the Fed the "pawnbroker of last resort." Ouch!
The Fed, Wall Street's pawnbroker of last resort.
And the Fed is bailing the banks out by buying their rotten assets through the TAF.
I don't think so: pledging assets isn't selling them.
The fake Rolex isn't the pawn-broker's just yet....
It's more like the Japanese zombie banking situation. The banks are technically alive but they won't be lending much until they rebuild their balance sheets. The Fed's action does nothing much to solve that medium/long term problem, it just keeps the life support switched on.
In the meantime, it looks like a further deterioration in the Banks' balance sheets is on the way once the economy really starts to dive, and defaults start to rise. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
The Fed will allow the banks to walk away from their TAF loans.
That gives rise to a whole chunk of political risk already rehearsed in the UK with the now nationalised Northern Rock.
The UK Treasury is shitting themselves about the fall out when people start defaulting on all the 100 to 125% mortgages Northern Rock were so free with, and which are all now coming to the end of fixed price deals and reverting to totally unaffordable rates.
Oh dear. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
...and it is then functionally the same outcome as if the Fed did lend directly to Joe Sixpack, because the Fed are going to end up holding the keys to the house Joe Sixpack walked away from, or is going to....
Not completely functionally equivalent. Northern Rock will look like a highly virtuous operation, run in the public interest. But in the US, the banks will keep humming happily, having off-loaded their crap on a perfectly willing Fed, and the public will pick up the tabs under the form of monetary inflation.
And "everybody who matter" will applaud loudly, marveling at how astute the Fed is at avoiding the Japanese zombie bank situation.
Anyway, what will be broken in the process? The general trust in the US financial system? There isn't much left to be broken, I'm afraid.
Unless we have an FDR^2 in the White House next year, someone willing to pull the gun on the financial sector and repossess the shop, modern capitalism will work as it always does : privatize the profits, socialize the losses.
But in the US, the banks will keep humming happily, having off-loaded their crap on a perfectly willing Fed, and the public will pick up the tabs under the form of monetary inflation. And "everybody who matter" will applaud loudly, marveling at how astute the Fed is at avoiding the Japanese zombie bank situation.
But in the US, the banks will keep humming happily, having off-loaded their crap on a perfectly willing Fed, and the public will pick up the tabs under the form of monetary inflation.
Now this has been the subject of much debate here at ET.
There's a big difference between the absence of deflation and the presence of inflation.
The Fed picking up the crap merely means the banks don't default. It may keep them liquid, but it still does nothing for their balance sheet, and thence their ability to lend.
And it is their ability to lend that causes asset price inflation, but not, IMHO retail price inflation.
The Fed bailing out banks is neutral in monetary terms - it does nothing to put new money into circulation, which would be inflationary.
The only inflationary US factors I can see are the rising costs of imported raw materials and consumer goods, and if there is not much money around as wages to buy these things then higher prices will not be sustainable and profits are going to get squeezed. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
The scenario is:
The other approach, as we both agree, is 1) to force the financial sector to liquidate its rotten assets and wipe out the leverage - meaning for nearly all actors in the financial sector to go under, fold and lose their shirts and their underpants - 2) inject liquidity directly in the economy by taking over the failed actors and restructuring debts and deposits in the productive sector so the real economy is not hurt (too badly).
But this is not going to happen.
By the way, it's quite possible for the Fed to bear large losses (on behalf of the banks) without anyone noticing. They can print money for free, but that does show up as increased liability on their balance sheet. Luckily, the Fed earns a spread from the interest bearing securities it holds against the no interest currency with which it finances purchases. So long as the losses it bears are smaller than this spread, losses can be hidden in reduced profit rather than showing up as embarrassing balance sheet holes. That amounts to tens of billions in loss-bearing capacity per year. By timing the recognition of losses, the Fed can finance very large losses over a period of years without politically awkward balance sheet issues.
So long as the losses it bears are smaller than this spread, losses can be hidden in reduced profit rather than showing up as embarrassing balance sheet holes.
That amounts to tens of billions in loss-bearing capacity per year. By timing the recognition of losses, the Fed can finance very large losses over a period of years without politically awkward balance sheet issues.
quote from waldman which is also elsewhere in the Comments to this Diary, because it is a correct representation of what lies behind the smoke and mirrors of Central Banking.
However, it does not address inflation, which is the issue here, and presupposes that no-one will notice the "bail-out".
Francois in Paris:
It will be inflationary if the Fed is deliberately complacent on the valuation of the collaterals offered by the banks to the TAF. The scenario is: Banks borrow at the TAF and the TAF accepts banks' rotten assets at a grossly inflated value, slightly below facial value to "be tough" on the banks but way above what a market would bear if there was a market left in the first place to negotiate those turds.
I think you are confusing the Capital the banks hold with the credit swirling around the system which the Banks created and implicitly guaranteed, backing that guarantee with their capital.
Whether the Fed takes collateral or not, and what the quality is of the collateral they do take, does not affect the amount of credit in circulation, merely the risk the Fed is taking in its dealings with the relevant banks.
The Fed lets the banks walk on their TAF loans and keep the rotten assets. The banks have effectively sold their rotten assets at an inflated value. Money for nothing and piles of cash to inject in the economy.
Hang on a minute, I think your logic fails at this point: are you saying that the Fed pawnbroker would quietly let the Banks walk away, leaving the Fed with the fake Rolex?
I don't think that would be possible, because it could not remain hidden, I suspect, and if it is done transparently then politicians, in the US or more likely overseas, would have a field day.
I give you that if it were possible, it would indeed repair the banks' balance sheets, which would allow them to create new loans=credit=money and perhaps then refinance distressed borrowers enough to stabilise asset prices.
But that doesn't reinflate the bubble - merely stop it deflating, and it does nothing for retail price inflation because none of the money will get out into circulation anyway.
It's the only "acceptable" way the Fed has to inject cash (and inflation) in the system as the open market operations are broken and may even be deflationary at this point.
I don't think so. The best the Fed can do is to avoid deflation by providing "quasi equity" through pumping in liquidity for as long as it takes banks to rebuild their balance sheets.
The Japanese have been trying - and failing - to bring back, - a conventional rate of inflation for years using monetary means and are still failing.
The other approach, as we both agree, is to force the financial sector to liquidate its rotten assets and wipe out the leverage - meaning for nearly all actors in the financial sector to go under, fold and lose their shirts and their underpants - inject liquidity directly in the economy by taking over the failed actors and restructuring debts and deposits in the productive sector so the real economy is not hurt (too badly). But this is not going to happen.
The other approach, as we both agree, is
Well I believe that there is another way to do this which is a "debt/equity" swap on a fairly cosmic scale by "unitising" the flows of land/property rentals and energy which actually constitute value rather than a claim over value issued ex nihilo by a credit institution aka bank.
This essentially takes us to Keynes' International Clearing Union concept. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Yes, I think that the system has become that corrupt. Otherwise, the Fed needs to nationalize the banks and that cannot be done. It would be socialism and it would hurt friends.
You mean a field day like they already had one on the bullshit about Iraqi aluminum tubes and biological labs on trailers? Yeah. It worked really well.
You've seen Mozilo, O'Neal and Prince in front of the House Oversight committee on Friday, right? It's not really that they are disconnected from reality. They are very well connected into reality. They simply don't give a shit. Nothing the government can do unless it takes radical steps to lock them up, seize their assets and, more importantly, given the hold of the ruling class on mass media, to muzzle them. Can't happen. The government would have to turn upside down the two major tenets of Murika, property rights and freedom of speech (for those who own a lot of property and the loudspeakers).
And silly furiners, well, they are already voting with their feet if you look at the dollar/euro exchange rate. Anyway, no one cares about silly dirty furiners in Murika. They are nasty Yank-haters and if they bark, US politicians will blame them for hurting the US economy.
The money will get out in circulation because it won't go to the housing bubble but somewhere else. You can count on them to find an other way to push US consumers deeper into debt. The housing bubble will be the Fed problem, which will tide it up by throwing free money to support existing loans with very low rates and by holding rotten loans outside of the market.
It's not about the economy. Ultimately, I'd say it's not even about the financial sector. It's about saving the ruling class at everybody's else expense. All the rest can be blamed for the commoners on nasty furiners: China, petro-monarchies, Europeans, etc. They don't give a shit if the economy tanks and everybody else is impoverished as long they can hold and reinforce their relative position. It can actually help them by making their targets weaker for their predation. If there is a shock, great! Just another opportunity to push for more "reforms".
Chris, I think your problem is that you seriously underestimate how degenerate and shameless modern capitalism has become. You are still trying to look at it as if it was run in everybody's interest. You are 25 years late.
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Actually, something about the House hearing shocked and depressed me quite seriously. AFAIK, it was focusing on fuzzy notions of fairness about the CEOs pay.
But (AFAIK) no one pointed out the absolute obvious : a corporation doesn't go from record profits to abysmal losses overnight. For that to happen requires grossly rigged accounting, either out of staggering incompetence or outright fraud, or both. In that case, the answer is clear and deliberate fraud and it doesn't matter if it is wrapped in GAAP, anointed by audit firms and backed fantasy mark-to-market valuations on markets where no one gives a shit about what they are buying and selling. It was clearly not borne by any reality, very much like the famous opinion letters used by Enron to justify its accounting acrobatics. It was just mutual back-scratching in a giant Ponzi scheme.
Put plainly, fraud.
So no one pointed out that the CEOs outlandish pay days were "justified" by completely unsubstantial and fraudulent accounting and were never earned in the first place.
I was a Director of the IPE (now ICEFutures) and blew the whistle in 2000/2001 on how the investment banks were (and still are) milking the oil (and energy) markets, and got shafted because of it.
So yes, I do understand how shameless modern capitalism has become more clearly than most, both in terms of inside knowledge and personal experience.
You are assuming that the rest of the world will look on blithely, watch the Fed pumping in gazillions of dollars to bail out banks' balance sheets, and do nothing about it.
It simply won't happen. The dollar would disappear up it's own backside.
The Japanese had to work things out over time, and the same discipline will IMHO be forced upon the US.
Credit intermediation is finished in the US and Wall Street is going to have to find an alternative. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Those fuckers would sell their country into slavery if they could and it'd help them to make a buck. So blowing up their own currency, they won't care a wit. They won't be the ones suffering.
