Balneus

Australian Lefty on Politics, Governance, Science and Info Management

The US Fed, lowering interest, the scam

Posted by Dave Bath on 2007-08-28


VoxEU have another two papers on the recent crisis in the financial markets, and critically examine the actions of reserve banks, and in particular the lowering of interest rates in the US.  Basically, one analysis says the banks who borrowed money from the reserve banks got an almost zero-penalty loan for their stupidity, and the other says the US Fed should have given the discount rate only to those banks who accepted more regulation and oversight.

It’s worth noting the authors credentials with the names of these two papers: they are not by mere academics, but practitioners who’ve had a lot to do with monetary policy in the US and Europe.

  • "A missed opportunity for the Fed" (2007-08-18) which says the US Fed did not take the appropriate actions is by
    • Willem Buiter, Professor of European Political Economy at the London School of Economics and formerly a member of the Monetary Policy Committee of the Bank of England and Chief Economist at the European Bank for Reconstruction and Development; and
    • Anne Sibert
      Professor and Head of the School of Economics, Mathematics and Statistics at Birkbeck College, London; and an advisor to the Committee for Economic and Monetary Affairs of the European Parliament.
  • "Federal Reserve Policy Actions in August 2007: Answers to More Questions" (2007-08-27) points out that the banks who borrowed got dirt cheap money, even though they provide details to the US fed board (who are all bankers and cycle quickly back to industry – so there is disincentive to borrow) by Stephen Cecchetti, Professor of Global Finance at the International Business School, Brandeis University, formerly Executive Vice President and Director of Research at the Federal Reserve Bank of New York.

The first paper (Missed Opportunity) includes the following comment which tells us how the US Fed (or our RBA) will act dependen on whether they want to help the economy or the financiers:

At least the Fed did not cut the monetary policy rate (it only cut the discount rate to banks – my interpolation). …  But addressing the problem of illiquid financial markets using the blunt instrument of monetary policy, a cut in the monetary policy rate, would be clear confirmation that the Fed is concerned about financial markets over and above what these markets imply for the real economy.

Cecchetti goes into the details of the rules governing the US fed, and Australia’s RBA didn’t touch interest rates (merely injecting lots of cash into the financial markets), it’s still relevant to us here in Oz.  He also looks at exactly how much it cost the banks to borrow the squillions from the US Fed – enough to make a borrower on the overnight money markets drool….

So the daily cost of this is the difference between these two – that turns out to be a total of about $29,250 per day, or $7300 per bank per day.  To put that into perspective, a bank CEO with annual compensation of $10 million per year is paid nearly 4 times that per day, 365 days per year.  So, the four large banks that borrowed were able to purchase some goodwill at what looks like a pretty low price.

Now, combine Cecchetti’s analysis of the low cost of borrowing by the banks and this from the first paper:

It is of course essential that ‘moral hazard’ be minimised. This ‘bail out’ of the illiquid by the Fed should be sufficiently costly that those paying the price would still remember it during the next credit boom, and act more prudently.

The definition of moral hazard indicated by the first paper is:

moral hazard – (economics) the lack of any incentive to guard against a risk when you are protected against it (as by insurance); "insurance companies are exposed to a moral hazard if the insured party is not honest"

The message the finance industry seemed to get from the reserve banks (the insurer in this case) was not "don’t be so negligent/stupid again or it will hurt you", but "we’ll do everything we can to keep you happy, even though you’ve been negligent/stupid, and we’ll keep on doing it time after time".

Would governments be so generous to the people who go into mortgage defaults?

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5 Responses to “The US Fed, lowering interest, the scam”

  1. Raf said

    Now you’re really trying to get me going here :-)

  2. Dave Bath said

    Raf, well, …. go on…., penny for your thoughts….

  3. Raf said

    Well the Fed minutes reveal that they were quite worried about this credit crunch, saw it coming and hoped it would blow over.

    In short, the private banking system is too big to fail so they will always get bailed out. Of course there will be some casualties but they will be picked up on the cheap but the survivors and so the merry go round continues.

    The flow of money is crucial to our societies. See my post on oil, money, love: the energy flow of life.

    The problem is that the powers that be have abdicated the power of money issuance to the private sector who of course will attempt to extract maximum profit from it.

    Yet it is the central banks (some privately owned eg the Fed, some publicly owned eg. RBNZ) who have to provide the cash when it all falls apart as it is mathematically designed to do.

    Those papers are good but they never understand the root of the problem.

    As Jefferson told us, we, the people, must take back the power of money issuance for ourselves.

    Otherwise we will remain slaves in perpetuity.

    “Mortgage” = The Grip of Death.

  4. Bruce said

    who have to provide the cash when it all falls apart as it is mathematically designed to do.

    I wouldn’t go as far as saying “designed”, but rather “inevitably destined” with the powers that be in a state of denial. ;-)

  5. Raf said

    Well perhaps not designed though anyone who understands compound interest and the nature of money creation would wonder what devious mind put this together.

    Imagine every day knowing there wasn’t enough money in the world to pay back the previous day’s interest and that the only way of getting that extra money was to create more new money.

    And that new money comes in the form of debt which, yes you guessed it, has more interest attached to it :-)

    Have a read through the “Nature of Money” paper on my website. The author, a former bank risk analyst, has done some serious computational work on the maths of compound interest and its effects on the real economy.

    As for the “powers that be”…..about time we had a look at who they actually represent.

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