Brad Setser

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Extraordinary times

by Brad Setser
September 26, 2008

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

And what have the rest of the world’s central banks done over this period?

There has been a lot of talk that central banks would abandon US assets because the perceived risk of holding dollars (and Treasuries) has gone up.

The custodial data though don’t provide much evidence to support this theory.

Over the last two weeks, the Fed’s custodial holdings have increased by over $40b, rising from $2394.7b to $2435.9b. Treasuries account for over $30b of the increase, but Agency holdings are rising as well. Chalk up one (minor) success for Paulson.

Right now, it seems like central banks are running into the safest US assets, not running away from the dollar. That of course could change. But it is hard to square a $20b weekly increase in the New York Fed’s custodial holdings with a story based on a fall in central bank demand for dollars. For that matter, it is hard to square the $425b increase in the New York Fed’s custodial holdings since last September with all the of the angst about the dollar’s status as a reserve currency.

If anything, the pace of growth in the Fed’s custodial holdings over the past two weeks strikes me as stronger than the likely pace of global reserve growth. That suggests to me that central banks are shifting funds out of the commercial banks (and money market funds) into Treasuries that can be held at the Fed’s custodial accounts. I would bet that central banks are shifting money to the BIS as well.

Remember, most central banks do not have a mandate to take credit losses. They can take currency losses — as currency risk is implicit in the notion of foreign exchange reserves. But having money in a bank that fails would be very hard for most to explain.

Note that all my data compares the data for the end of the reporting week, i.e the data for September 24 to the data for September 10.

UPDATE: I should have noted a fall in the Fed’s repos with the banks in my initial post. The changes in the Fed’s balance sheet are so large that I am not sure that I still know how to read the report, so please attach an error bar to the numbers above (apart from the numbers on the custodial holdings). I may have missed some additional credit extension, or some offsetting items. The basic story though is clearly true: the changes in the Fed’s “other loans” alone are enormous.


  • Posted by Allroads



    My only question is at what layer of the onion are we?

    The current administration is 60 days from turning over the keys and my fear is that it is only when the keyboards are replaced that we will see the full extent of the problem is.


  • Posted by manch

    Why can’t the central banks park their reserves in yen or euro? Is it just out of sheer inertia?

    China just started using some of its reserves to prop up the market there, although the amount is very small for now. If global recession takes hold, seems more governments will be using more reserves to stimulate their own economies. Is that a fair assumption?

  • Posted by vincie

    Chatwin tells the (probably apocryphal) story of meeting an elderly Taoist priest in China in the 80s. “What did you do during the Cultural Revolution?” he asked him. “I went for a long walk in the mountains.”

    Time to go take a long walk in the mountains.

  • Posted by moldbug
  • Posted by Peter

    My prognostication is that, if there is a run on the dollar, it will take one of two forms:

    1. a gradual increase in net private capital outflows culminating in a spike that leaves sovereign creditors struggling to recycle, or

    2. an sudden, unanticipated decision by a major sovereign creditor to pull out of dollars, which leads very quickly to a general rush to the exits

    What I don’t expect to see is a gradual shift out of dollars on the part of these same public creditors. The Fed holdings you report, Brad, are consistent with scenario 1. I should emphasize that I am not predicting that either of the two must occur, just that they suggest themselves on the basis of who the decision-makers are, how concentrated they are, and what their motives are.

  • Posted by Edwardius

    What is wrong with bankruptcy?

    In any other industry if the financial institution is over-leveraged, the firm declares bankruptcy. Bankruptcy is a systematic and rational system for re-allocating resources. It provides an automatic stay to stop immediate collections on debts, it even allows the bankruptcy judge to review transactions in the past 6 to 12 month depending on the relationship between the debtor and creditor. It also allows for debtor in possession financing. Normally this system is considered a relatively fair way to apportion losses among creditors.

    Yet in all of the news coverage, the newspapers keep saying that there isn’t enough time to prepare for a bankruptcy and that is why we need to act now to the tune of 700 billion or so.

    What is the rush and why are the banks so different from all other bankrupts? I know that the investment banks historically have been major contributors to both political parties. Are they merely using there political power to socialize the losses on the rest of society or is there some other better explaination for this bailout?

  • Posted by KnotRP

    Edwardius – most financial cons require the mark not knowing who took him. A bankruptcy judge would necessarily identify the culprits, and might even clawback ill gotten gains. I’d guess there is a big lobby working against that, and none working for it….

  • Posted by Edwardius

    Is it merely a con, or is there some substantive rational for the bailout that escapes me?

    I am curious why bankruptcy isn’t the preferred option here.

    The bankruptcy code even provides different chapters for reorganization (chp 11) or liquidation (chp 7). If the problem is too much debt, but the entity still has economic value, than the firm should file a chp 11 to save the economic value of the entity. Chp 11 provides for cram down provisions to remove debt from the books of the entity. If the entity has no remaining economic value than liquidation is the preferred alternative.

    In general bankruptcy is a necessary part of capitalism. In industries with too much capital, high levels of returns attract more capital to the industry. But in industries with too much capital chasing too little productive investments, in that situation bankruptcy is the systematic and rational way of reallocating the capital out of that sector.

    My understanding of what caused the problem in Japan after its property bubble crashed was that the government kept subsidizing the banks so that no loans would be called in with the idea that it would preserve jobs at the firms with the bad loans.

    But because these bad loans weren’t removed from the banks via bankruptcy, the returns on the loans portfolios for the banks were negative or close to it, so in effect few new loans were made because few loans were profitable.

    I guess what I am wondering about is whether this bailout is just repeating the same bad mistakes the Japanese took after they had a stockmarket/property bubble implosion?

    Why isn’t getting rid of some of the excess capital in the financial sector via bankruptcy considered a good idea? Then there won’t be too much capital in the sector and investmests in the sectors should be profitable attracting new capital.

  • Posted by Edwardius

    One other thought – what about the moral hazzard issues? A few well placed bankruptcies will encourage future CEO’s to not overleverage there firms in the first place. The markets will put a renewed premium on solid balance sheets.

    In bankruptcy contracts get broken. If the CEO’s were paid too much, the bankruptcy judge can treat there compensation package like other debtors of the firms.

  • Posted by London Banker

    Excellent and timely, Brad. I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

    The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

    The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed – only emphasise the urgency.

  • Posted by Pej

    Many thanks for this post. May I recommend to read this as well:

    The Black Swan and the Fed

  • Posted by Jim Pivonka

    I’ve been under the impression since Lehman went under that fear of institutions going bankrupt is not the issue at all. Instead, it was what happened to AIG as a consequence of the Lehman problem that created Paulson’s sense of urgency.

    AIG, if I understood the story, was exposed to Lehman CDS’s to a degree it became insolvent when Lehman went under. A bankruptcy for AIG would have multiplied that problem exponentially because of the size of its CDS involvement. In other words, additional institutions would have been taken down by the AIG bankruptcy, in a chain reaction.

    So bankruptcy becomes a contagion, instead of an isolation or object lesson.

    And, since world money supply is tied up with these institutions leverage in such as CDS’s and CDO’s the money supply evaporates too. Replacing that money supply would require action by central banks and governments that would raise a lot of political and economic issues.

    So, it seems better to stop the contagion at the first level – and bankruptcy won’t do that.

    I’d appreciate correction of my error, if I have misread this somehow.

  • Posted by fresno dan

    Thank you for your insightful analysis. Your objective critical evaluation contributes to a much greater understanding of the current financial problems

  • Posted by Dave C.

    From Bloomberg, More than 150 prominent U.S. economists, including three Nobel Prize winners, oppose the US taxpayer bailout of Wall Street

    Advocates for a rescue plan this week point to a seizing up of credit markets, reflected in elevated inter-bank lending rates, as reason for action. Some economists are unconvinced.

    “I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

    Robert Lucas, a University of Chicago economist and 1995 Nobel Prize winner who signed the letter. “The situation may get urgent, but it’s not urgent right now. Right now it’s a financial sector problem.”

    Jeffrey Miron, a Harvard University professor objects to what he says is “ a stunningly broad, aggressive government intervention without appropriate precedents.”

    He advocates allowing the normal process of business failure and bankruptcy to run its course. “It’s just nothing like the calamity the administration is making it out to be,” he said.

    Erik Brynjolfsson, of the Massachusetts Institute of Technology’s Sloan School, said his main objection “is the breathtaking amount of unchecked discretion it gives to the Secretary of the Treasury. It is unprecedented in a modern democracy.”

  • Posted by Dave C.

    Please write your Senator now to protest this injustice …

    From Bloomberg, the U.S. Treasury “is totally dominated by Wall Street investment bankers” and “cannot be relied on to objectively assess” the impact of government policy on the financial industry

    U.S. Treasury Secretary Henry Paulson’s proposed $700 billion bank rescue aims to help “poorly run” companies and the primary beneficiaries would be Goldman Sachs Group Inc. and Morgan Stanley, said BB&T Corp. Chief Executive Officer John Allison in a critique of the plan.

    Treasury “is totally dominated by Wall Street investment bankers” and “cannot be relied on to objectively assess” the impact of government policy on the financial industry, Allison wrote in a Sept. 23 letter to Congress. The letter was verified by Bob Denham, a spokesman for BB&T, North Carolina’s third- largest bank.

    Allison, 60, said Congress should “hear from well-run financial institutions” as lawmakers consider the plan, which seeks to ease the credit crunch by buying troubled mortgage- related assets. Under Allison, Winston-Salem, North Carolina- based BB&T avoided the subprime mortgage market, whose collapse led to the credit crisis. BB&T has risen 26 percent this year, the best showing in the 24-company KBW Bank Index.

  • Posted by Dave C.

    China PBoC orders Chinese Banks to stop lending to U.S. banks.

    HONG KONG — Chinese regulators have asked domestic banks to stop lending to U.S. financial institutions in the interbank money markets to prevent possible losses during the financial crisis, the South China Morning Post reported Thursday. The China Banking Regulatory Commission’s ban on interbank lending of all currencies applied to U.S. banks, but not to lenders from other countries, the report added, citing a source.

    Related link:

  • Posted by bsetser

    Edwardius — Financial sector bankruptcy (see LEH) is a difficult thing. the value of a financial firm largely hinges on its ability to retain the confidence of its short-term creditors. so bankruptcy destroys most of its value. that is why there is a special regime for bust banks (WaMu); they don’t go into ordinary bankruptcy (the FDIC’s role as an insurer is important here too). Moreover, the bankruptcy of one firm tends to be contagious — individuals and creditors have a hard time telling whether one financial balance sheet is better than another, so a major bankruptcy can lead to a run (see Lehman and money market funds and the resulting pressure on Morgan Stanley).

    Finally, if all institutions go bust at once, who will come in and own the financial sector? In these kinds of circumstances globally (there are many cases of systemic banking crisis) the government usually temporarily assumes control of the banks. To address moral hazard, the banks’ equity is written down. and the moral hazard of protecting depositors/ other small creditors is ignored — b/c otherwise we would have to move to a world of much less leveraged intermediaries and much less credit, with associated social costs.

  • Posted by bsetser

    London banker — I think you are right to believe that the Fed’s concerns about the warehousing of risk on its balance sheet/ the risk it might soon run low on ammunition are one of the reasons for the plan. Of course, it is hard to argue that the Treasury should buy do what the Fed doesn’t want to lend against, so this argument doesn’t seem to have been made explicitly.

    i would appreciate it if you also took a look at the fed’s balance sheet and gave a second opinion on the net extension of credit …

  • Posted by London Banker

    @ Brad
    Accounting isn’t one of my strengths, so perhaps someone else would be better able to give that second opinion.

    I’m just competent enough to know that the humour in the following quote is dark: “The problem with financial institution balance sheets is that on the left hand side nothing is right and on the right hand side nothing is left.”

    I’ve cross-posted on my blog linking to you here:

  • Posted by RolfeWinkler

    And what about the $900b+ of FHLB advances? THat’s up $300b from the beginning of ’07. Just more evidence that the financial sector can’t function without fed gov’t support.

    Would be interesting to see how the WM bankruptcy will affect the CDS market. Lehman’s bankruptcy brought down AIG….

    Great work as always Brad!

  • Posted by Blissex

    «I am curious why bankruptcy isn’t the preferred option here.»

    There are two main types of bankruptcy here, chapter 11 which is restructuring as a going concern and chapter 7 which is liquidation.

    Many financial institutions are so insolvent (thanks to all their capital being wiped out by large leverage) that would not qualify for chapter 11; therefore they would have to be closed down, and this would mean a freezing of a large part of the financial system.

    Now, there are two ways to prevent this: giving them enough new capital, either by having them huge profits on asset sales, or by direct recapitalization, or to create new financial companies to take their place (or newly expanding the role of existing companies or institutions).

    The difference between the two choices means business as usual in the first case and a huge change of power and leadership in the the industry in the second case.

    Those already vested with high positions of power and leadership do not want to lose them. They are even opposed to the direct recapitalization of existing business because that could lead to new power and leadership structures if not immediately some time later.

    As one humourful guy said, the Paulson proposal is the first real example of “compassionate conservatism” of the Bush administration.

    It is compassionate because it gives out $700b as a gift, and conservative because it keeps all the existing executive teams in place.

  • Posted by Blissex

    As to tallies of the generosity of the Fed*mart and Treasury, here is another (somewhat more comprehensive) one:
    «-so, so, so is this the correct total?
    $1.8 Trillion? Oh. My. God!

  • Posted by JKH


    I see on the Fed’s balance sheet:

    Total factors supplying reserve funds:

    Sept 10 958,851
    Sept 24 1,248,819

    Change 289,968

    Factors supplying reserve funds is basically what’s happening on the asset side of the balance sheet; i.e. credit provision.

  • Posted by JKH

    ‘credit provision’ is not the best choice of words (usually means loan loss provision)

    credit extension or change in credit outstanding better in this case

  • Posted by JKH

    An equally interesting aspect of the Fed balance sheet in my view is the liability side. Both the bank reserve balances and Treasury balances with the Fed are extremely bloated. The Fed has goosed reserve balances because the system is so clogged with hoarding and possibly because the reserve effect of the foreign exchange swaps is still evident. Treasury balances are high because this is the residual financing required to fund the intended asset expansion and do it in a way that sterilizes the additional reserve effect that would otherwise occur.

  • Posted by RealThink

    I think the considerations by London Banker are answered by this view borrowed from a Hubbert’s Peak-aware banker:

    “The theory here is that the Fed has destroyed its balance sheet by taking on increasingly large chunks of non performing assets (the “toxic waste” made from mortgage-backed securities and the like) in exchange for loans of “real” cash to banks that may still end up not repaying them.

    It is effectively “broke.” This is not what is supposed to happen to a central bank, which can print money without restriction, so let me explain what this means: it can no longer help the banks in a non-inflationary way. In order to take on more toxic collateral from the banks, it would need to actually print money, which would immediately be visible and would be seen as very inflationary.”

    And the recent changes in the Fed’s balance sheet show exactly that what the last sentence above described as possibility (“would”) has become fact.

    “So this is a desperate gamble by Paulson and Bernanke to avoid the run on the dollar that would be triggered by direct cash creation.”

    Notably, direct cash creation had already happened in earnest by Sep 24, which means before the dealmaking process got stalled.

    And as Brad points out, the logically consequent run on the dollar has not yet come to pass.

  • Posted by Flabbergasted in Palo Alto

    Brad and friends,

    Since the concern is about the “real economy”, let us see whether you can find a venture that cannot be financed when there is a reasonable chance that the interest will be paid and the principal returned. I sincerely think that you will not be able to find a single example. At the level of the homeowner, anyone seeking an 80% down 30 yr conventional mortgage at 3 times his/her gross income will get a ton of offers.

    What has (finally!) become difficult to finance is Ponzi schemes and desperate households that have infinitesimal chance of ever repaying their loans and a high probability of defaulting on them. In California, perhaps as many as 50% of households run a deficit. Many survive by using their homes as ATMs. You can postpone the inevitable by throwing more money at them but you are not really helping them. Many of them can unshackle themselves by returning their houses to the bank and adopting a lifestyle consistent with their incomes. (An alternative solution would be to give everyone a 30-40% raise but I do not think that Congress plans to do that, not yet. :) ) I think most people on main street, Democrats or Republicans, understand this far better than pundits who look at TED spreads. That is why most people are against any bailout or other pricey band aid. Facing reality is always hard and we are in for a rather painful period. But it is inevitable. So, the sooner we get to face reality and start solving our problems, the better.

  • Posted by Cedric Regula

    I’ll post da details of da delta treasury additions for next fiscal year, from da blissex post. This totals $1.8T. Some of it came from da fed balance sheet, but if we assume da treasury will make da fed whole again next year, and also fund da projected fiscal deficit plus Iraq…then we can come up with da grand total so far..

    1.8T + 480B +90B = $2.37 Trillion
    Will dey spend dat in one year? It’s an emergency, so’s I guess da answer is yes.

    Did I mention we have a $700B trade deficit to finance too?

    Da good news is as usual another fine financial instituion blew up while I was at tennis night, but dey say dis one doesn’t cost us any money. So last night was da first night ina three weeks dat tennis night only cost me a can of tennis balls.

    —Up to $700 billion to buy assets from struggling institutions. The plan is aimed at sopping up residential and commercial mortgages from financial institutions but gives Treasury broad latitude.

    —Up to $50 billion from the Great Depression-era Exchange Stabilization Fund to guarantee principal in money market mutual funds to provide the same confidence that consumers have in federally insured bank deposits.

    —The Fed committed to make unspecified discount window loans to financial institutions to finance the purchase of assets from money market funds to aid redemptions.

    —At least $10 billion in Treasury direct purchases of mortgage-backed securities in September. In doubling the program on Friday, the Treasury said it may purchase even more in the months ahead.

    —Up to $144 billion in additional MBS purchases by Fannie Mae and Freddie Mac.The Treasury announced they would increase purchases up to the newly expanded investment portfolio limits of $850 billion each. On July 30, the Fannie portfolio stood at $758.1 billion with Freddie’s at $798.2 billion.

    —$85 billion loan for AIG, which would give the Federal government a 79.9 percent stake and avoid a bankruptcy filing for the embattled insurer. AIG management will be dismissed.

    —At least $87 billion in repayments to JPMorgan Chase for providing financing to underpin trades with units of bankrupt investment bank Lehman Brothers. Paulson said over the weekend he was adamant that public funds not be used to rescue the firm.

    —$200 billion for Fannie Mae and Freddie Mac. The Treasury will inject up to $100 billion into each institution by purchasing preferred stock to shore up their capital as needed. The deal puts the two housing finance firms under government control.

    —$300 billion for the Federal Housing Administration to refinance failing mortgage into new, reduced-principal loans with a federal guarantee, passed as part of a broad housing rescue bill.

    —$4 billion in grants to local communities to help them buy and repair homes abandoned due to mortgage foreclosures.

    —$29 billion in financing for JPMorgan Chase’s government-brokered buyout of Bear Stearns in March. The Fed agreed to take $30 billion in questionable Bear assets as collateral, making JPMorgan liable for the first $1 billion in losses, while agreeing to shoulder any further losses.

    —At least $200 billion of currently outstanding loans to banks issued through the Fed’s Term Auction Facility, which was recently expanded to allow for longer loans of 84 days alongside the previous 28-day credits.

    -so, so, so is this the correct total?
    $1.8 Trillion? Oh. My. God!

  • Posted by Dave C..

    Economist Marc Faber says even a $700 billion taxpayer bailout won’t make any damn difference to fix the financial problems.

    $700 billion may not be enough to bail out Wall Street says one analyst, given the lack of transparency and the length and breadth of financial markets involved.

    Marc Faber, editor & publisher of ‘The Gloom, Boom & Doom Report’, told CNBC’s Asia Squawk Box on Friday, he doubts that $700 billion would make any difference when you consider the size of U.S. credit markets.

    “Looking at the size of the credit market in the United States, the equities market, the housing market and then looking at the size of the credit default swap market, which is around $62 trillion now, and the world wide derivatives market which is now $1,300 trillion dollars, I very much doubt that $700 billion would make any difference at all. In fact, I think it’s a bad proposal in the sense that it will distort market pricing,” Faber said.

    He added that the current bailout plan proposed by the Treasury and the U.S. Federal Reserve does not address this leverage problem in the markets.

    “My friend suggested what would be much cheaper—go in and buy a million homes in the United States and burn them down. Because that will reduce the supply. Of course it is an economic nonsense solution, but it is as good as the Treasury’s proposal,” Faber quipped.

  • Posted by RebelEconomist


    I would not read too much into the increase in Fed custody holdings. As I explain on my blog ( ), I think that an increase in custody holdings would be expected because of the collateral taken by the central banks lending under the reciprocal swap lines arrangement.

  • Posted by Dave C..

    A Big Surprise!!

    Dallas Federal Reserve Bank President Richard Fisher opposes Bernanke-Paulson bailout for Wall Street banks

    Dallas Federal Reserve Bank President Richard Fisher said the proposed $700 billion rescue of financial institutions backed by Fed Chairman Ben S. Bernanke would plunge the U.S. government deeper into a fiscal abyss.

    The plan by Treasury Secretary Henry Paulson to buy troubled assets from financial institutions would put “one more straw on the back of the frightfully encumbered camel that is the federal government ledger,” Fisher said today in the text of a speech in New York. “We are deeply submerged in a vast fiscal chasm.”

    Fisher made the comments as the central bank expands its role in the biggest government intrusion into markets since the New Deal, with Bernanke trying to persuade Congress to approve Paulson’s bailout plan.

    Bernanke has already cut the benchmark interest rate at the most aggressive pace in two decades, invoked emergency powers to loan to securities firms and pumped billions of dollars into banks to try to restore liquidity. Also, the central bank loaned $85 billion this month to American International Group Inc.

    “The seizures and convulsions we have experienced in the debt and equity markets have been the consequences of a sustained orgy of excess and reckless behavior, not a too-tight monetary policy,” Fisher said to the New York University Money Marketeers Club.

    “I was, and I remain skeptical, that lowering the fed funds rate is the most effective antidote,” he said. “Rates held too low, too long during the previous Fed regime were an accomplice to that reckless behavior.”

  • Posted by Edwardius

    I know that there are several formulation of Bagehot’s rule, but wasn’t the central one that central banks should close down insolvent institutions and lend freely at a penalty to illiquid one’s?

    Isn’t a lot of this financial panic because so many lenders are actually insolvent? They have too many non-performing mortgage backed securities on their books that are defaulting at rates much higher than the models predicted wiping out there capital.

    With commerial banks, I understand the rational for intervention by the fed, to provide liquidity to solvent but illiquid banks as well as to minimise losses on insured FDIC deposits.

    But what is the rationale for intervention on bahalf of investment banks? They don’t have a host of FDIC depositors nor do they don’t appear to be solvent.

    Why not let them fail and let other firms buy up the economically viable part of the business out of bankruptcy or just hire the talented individuals to set up investment banking functions in new better capitalised entrants to the market. (Maybe GE, Wells Fargo or Microsoft start up investment banking divisions)

    I realise that many counter parties on the derivatives will go bust if we let some of these banks fail. But if the counter parties are also so poorly capitalised, how economically productive were they in the first place? Why not let them fail too? If we do, we clean up the books in the industry and create space for new better capitalised entrants.

    Every year thousands of firms fail. 4/5’s of all restaurants fail within 5 years, yet we aren’t bailing out the restaurant industry. The individuals working in the finance industry are some of the nations best and brightest. If they aren’t working in finance, they will find other well paying positions.

    700 billion dollars is a tremendous amount of capital. If we add that to the existing national debt, aren’t we just increasing the risk that foriegn lenders are going to stop lending to the US and cause a run on the dollar? How much debt to GDP can a country have before foriegn lenders figure that lending to the US is just too big of a risk of not getting paid back either because of default or because they will get paid back by dollars devalued substanially by inflation?

  • Posted by Cedric Regula

    Edwardius: The individuals working in the finance industry are some of the nations best and brightest. If they aren’t working in finance, they will find other well paying positions.

    Uncle Bruno tinks dey should be wearing orange jumpsuits ana do community service for a long while.

    An’ wid a $2.3 Trillion bill coming up next year you can add US investor flight to lack of foreign investment coming in.

  • Posted by globumedes


    “Edwardius Says:
    I am curious why bankruptcy isn’t the preferred option here.”

    “bsetser Says:
    Edwardius — Financial sector bankruptcy (see LEH) is a difficult thing.”

    Who has credible signs, that throwing the 700bn tax-money in the gambling system will produce something else then a prolonged way to the hell?

    I ask: Is the “shadow banking system” really a sector of the financial system and not a sector of the gambling industry?

    I would suggest:
    1. let the gambling bank system go to hell,
    2. put the 700bn in one/two of the best big banks, the regional banks and the local banks.
    3. Then US will have a more or less sound financial basis for the normal industrie and can go for a new start.


  • Posted by Dave C..

    What Paulson’s taxpayer bailout for Wall Street insiders is really about

    No economy can grow at steady exponential rates; only debts can multiply in this way. That is why Mr. Paulson’s $700 billion giveaway to his Wall Street colleagues cannot work.

    What it can do is provide a one-time transfer of wealth to insiders who already have been playing the debt-credit system and siphoning off its predatory financial proceeds to themselves. The Wall Street bankers, brokers and fund managers to whom I’ve been speaking for many decades all know this. That is why they pay themselves such large annual bonuses and large salaries each year. The idea is to take as much as you can. As the saying goes: “You only have to make a fortune once in a lifetime.” They have been salting away their fortunes year after year, mainly in hard assets: real estate (free of mortgages), fine furniture, boats and trophy art.

    Their plan now is for icing on the cake – to take Mr. Paulson’s $700 billion and run. It’s not a “bailout of the financial system.” It’s as giveaway – to insiders, to sell out all their bad bets. Companies across the board will get rid of their bad mortgages, and also their bad car loans, furniture time payments, credit-card loans, student loans – all the debts that any competent actuary could have told them never could have been paid in the first place.

    This is not what Treasury Secretary Paulson is acknowledging, and shame on him for it. Last Friday, Sept., he was joined by Fed Chairman Ben Bernanke singing in unison an advertising jingle for America’s new kleptocracy that rings so false that Congress and the American public must hear the off-notes. London’s Financial Times, as well as a host of Europeans realize it. That is what has been driving the dollar’s exchange rate this week. It seems easier for foreigners to recognize the threat to turn American democracy into a rapacious kleptocracy.

  • Posted by 3.1415

    Will the bailout work? The most optimistic answer is maybe. Since this decision is best made by the professionals, where is the voice of the professional organization? In my field, there is the Society for Neuroscience, the National Academy of Science, etc. If someone is proposing adding some magic drug in our drinking water to rid the nation of obesity or the potential to get obese, I am sure that the profession societies will put out a position paper on whether it is a good idea. Is there a Society for Economists in the US? If the former chairman of Princeton’s economics department cannot convince his colleague Professor Krugman, who’s demanding adult supervision of Comrade Paulson, and by extension Comrade Bernanke, we really need some consensus from the pros here. The heretic Dr. Roubini can only manage to get his ideas heard by his followers. Could the economists in the US please have an online vote right away on the $700b bailout? And if the vote is no, please come up with a few options that they can vote on. I am being naive here, but the bailout is going to have an effect on all of us, good or bad. Some disinterested professional advice is urgently needed.

  • Posted by Dave C..

    The Taxpayer bailout won’t work say 190+ leading US Economists

    Bloomberg is reporting Hundreds of Economists Oppose Taxpayer Bailout Plan

    More than 150 prominent U.S. economists, including three Nobel Prize winners, urged Congress to hold off on passing a $700 billion financial market rescue plan until it can be studied more closely.

    In a letter yesterday to congressional leaders, 166 academic economists said they oppose Treasury Secretary Henry Paulson’s plan because it’s a “subsidy” for business, it’s ambiguous and it may have adverse market consequences in the long term. They also expressed alarm at the haste of lawmakers and the Bush administration to pass legislation.

    David I. Levine, a professor of economics at University of California-Berkeley, says the current plan being discussed has the wrong structure.

    Erik Brynjolfsson, of the Massachusetts Institute of Technology’s Sloan School, said his main objection “is the breathtaking amount of unchecked discretion it gives to the Secretary of the Treasury. It is unprecedented in a modern democracy.”

    “I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

  • Posted by 3.1415

    I found the AEA hidden in a site at Vanderbilt. Is this thing the professional organization of American Economists? Both Professor Bernanke and Professor Krugman can be found in its membership directory. Please bang the doors on AEA if you are fed up with their silence.

  • Posted by bsetser

    JKH — credit extension would have been a better choice of words.

  • Posted by Blissex

    «A Big Surprise!!
    Dallas Federal Reserve Bank President Richard Fisher opposes Bernanke-Paulson bailout for Wall Street banks

    Not at all! He is s dutiful Republican.

    Republicans have decided that they cannot go the election on their record as the party of government, which is awful, and anyhow their government is Bush, who is a lame duck and cannot be re-elected, and whose record is big spending big government.

    So their electoral strategy is to run as the party of opposition, blaming it all on big spending, big government Democrats who have ruined the economy first by causing all sort of problem with the GSEs and the CRA (and the Republican propaganda machine is following relentlessly the GSE and minority lending talking points), and now by supporting big spending, big government plans by Bush/Paulson, which are everything that the Republicans have been against.

    Perhaps the Bush/Paulson real plan is to play along with this strategy and to sucker the democrats into the role of looking like the enablers and heirs of his awful legacy.

    Yes the Democrats have been quite complicit, but nowhere like the Republicans, who are however now posing as the real opposition, the party of the people, the party that will clean out all this Bush/Pelosi big government big spending combination that has created all this sad situation.

  • Posted by Michael

    bs – You’re absolutely right that there is no CURRENT run from Treasuries, but rather a flight into them for safe harbor.

    It was also true that at the beginning of 2006 there was no flight from home buying, but rather a stampede into home acquisition; and in 2006 there was no flight from mbs, cdos, and all the non-Treasury debt. And many, many people refused to consider that these trends could – and logically should – reverse course.

    Failure to accept the obvious fact that creating unsustainable debt expansion leads to – often preciptiously sudden and sometimes unstoppable – debt contraction, and failure to take prudent action (even at the cost of losing opportunity to better your position in the short run) to prepare for such a contraction ARE AT THE VERY HEART of why we are now facing “The Great Unwind” in such a desperate fashion.

    Can I talk you into acknowledging the reality that simply knowing there has not yet been catastrophic dumping of Treasuries does not constitute full acceptance of that possibility? Especially in the circumstances of multiple trillion-dollar increases in the national debt ceiling (within months on a panic basis)? And if we don’t accept a flight from Treasuries as a highly probable outcome, we will not begin adequate preparations to deal with such a problem when it starts to unfold.

  • Posted by Dave C.

    Nouriel Roubini labels the Paulson bailout as an Absolute disgrace

    It is a disgrace that no professional economist was consulted by Congress or invited to present his/her views at the Congressional hearings on the Treasury rescue plan.

    Specifically, the Treasury plan does not formally provide senior preferred shares for the government in exchange for the government purchase of the toxic/illiquid assets of the financial institutions; so this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the firms; with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession.

    The Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown.

  • Posted by Dave C.

    Why the Fed and the Treasury bailed out Bear Stearns, Fannie, Freddie, and AIG, and not others such as Lehman Brothers may have less to do with saving the insurance business, the housing market, or the Chinese investors clamoring for a bailout than with the greatest Ponzi scheme in history, one that is holding up the entire private global banking system. What had to be saved at all costs was not housing or the dollar but the financial derivatives industry; and the precipice from which it had to be saved was an “event of default” that could have collapsed a quadrillion dollar derivatives bubble, a collapse that could take the entire global banking system down with it.

    So, there you have it! The horrible, naked truth finally comes out–not in the corporate mainstream media.

  • Posted by Rien Huizer

    There is really very little to analyse. But the politics are terrific. Have not had this much fun in years! Do not worry, everything will be allright, except for a few people who made bad decisions and a poor presidential candidate who will have an office without credibility and money and going straight into defeat at the next election. Looks like mr Gingrich found a little gold mine here.

  • Posted by Dave C.

    It’s not surprising the the CNBC pimps for Goldman Sachs would be pushing for Paulson’s bankster bailout. It has gotten to the absurd point that the US Treasury will be sending multi-billion dollar Corporate Welfare checks to Goldman Sachs monthly. General Electric owns CNBC, but CNBC is operated as the Ministry of Propaganda for Goldman Sachs. With only the exception of Rick Santelli from Chicago, the rest of the motley crew of CNBC financial analysts are on the Goldman Sachs payroll.

    Beware on any stock market tips by CNBC financial analysts. Goldman Sachs alumni Jim Cramer was pushing Bear Sterns stock two days before the bankruptcy. The unsuspecting US general public is duped repeatedly by massive disinformation.

    Paulson’s Taxpayer Bailout for Wall Steet to be approved with political payoffs to Congress

  • Posted by RebelEconomist


    There is not much point giving a link to Roubini when you cannot read it unless you are an rge client. I can imagine though that the man who seems to have a tenured university job while expecting to get paid for his opinions by the financial industry will be telling us that the greedy bankers should be made to suffer.

  • Posted by Flabbergasted in Palo Alto


    That was a totally senseless comment. The lifetime income of a tenured professor (more than 120000 hours of work) is less than one year’s bonus to one of the titans of industry that created this huge disaster. Everything is a matter of degree, my friend.


  • Posted by Rien Huizer

    London Banker,

    Good comments, but there may be more to it..

  • Posted by Rien Huizer

    3.1415. Cromwell’s supporters were nicknamed roundheads because of their rather pedestrian appearance. Your hiding behind the symbol of roundness does not excuse your unwarranted criticism of the AEA. Same heads like mine (someone who considers economics a pastime) enjoy reading AEA publications -on paper- and appreciate two things: (a) the ridiculously low price of the package (b) the distance from current affairs. Why on earth would a serious academic comment on this mixture of idiocy and vandalism that must pass for economic management in the US?

  • Posted by bsetser

    JKH — in addition to the $290b in credit extended to the financial system, i think the fed also increased its loans of securities to the broker dealers by $60b (this is reported next to the foreign custodial holdings), which would produce a net extension of $350b — plus whatever the ECB/ others did.

    Palo Alto — obviously, most people don’t worry about Ted spreads. And i accept that too many people have lived off debt rather than income for too long. the problem is that when this stops suddently, activity also stops suddenly — i.e. there is a recession. and the other problem is that those debts are the assets of the financial sector, and there currently does seem to be risk of cascading financial failure — hence all indications of distress in the credit market. and cascading financial failure means going from an economy with too much credit to one with far too little

  • Posted by jim

    The Fed can never be illiquid. They can create their own liquidity with their electronic printing press.

    They are free to create unlimited amounts of electronic dollars to buy unlimited amounts of treasuries or any other securities.

    This leads me to question why the federal government is creating this crisis to pass a bailout plan when it can be solved entirely with the Fed’s balance sheet without any legislation required.

    There is another game being played here. It’s not entirely clear what that is but we’ll find out shortly.

    I predict the bailout plan fails and the stock market crashes. This is what our government leaders want right now for some reason.

  • Posted by gillies

    the bailout could fail in its advertised objectives while succeeding in its ulterior objectives.

    they asked of nixon – “would you buy a used car from this guy ?”

    now ask of bush, bernanke, paulson – “would you make a loan to these guys to buy a used car they have already crashed ?”

    i see george bush not as a lame duck, but as the lame ugly duckling who turns out to be a black swan.

  • Posted by Cedric Regula


    In da old days Uncle Machiavelli used ta say “If’n yous feeds dem, dey just make more babies.”

    Uncle Bruno tinks it’s really dumb to force consumption growth(and production in Asia) in a world dat seems to be running out of space, natural resources, energy, water and air. Wads da use in mak’en babies?

    He’s recommending dat da Family restrict loan activity to overnight loans at da pool hall. He also recommends these be secured wida wedding ring, or car in da parking lot, or sum such collateral.

    He tinks it’s time da goombahs be taught da value of money.

  • Posted by ReformerRay

    If the Treasury can sell all the notes it wants at less than 4%, why cannot the FRB balance sheet be replisnished by Treasury?

    The banking crisis in Japan in 1989 lingered for a decade because the banks with bad loans were not allowed to fail. The U.S. is not making that mistake. Spurred by short selling and the desire of investors to get their money out of a “threatened” bank (or investment firm), several once powerful financial institutions no longer exist. The market is doing its job, without any help from Bernanke and Paulson.

    Look on the bright side. Everything when up during the period 2003 – 2007. Everything has to come back to earth before a resurgence can begin. Thanks to the rapid cleansing, wall street may be able to recover its footing much quicker than most expect.

    Bernanke is doing just fine in his primary job – to provide liquidity to financial markets when liquidity dries up in the private sector. Thanks to his timely action, dollars are available all over the world from Central Banks to provide funds to support short-term lending. He is being proactive in a very positive way as regards short-term liquidity.

    Bernanke is doing a very bad job as a forecaster. He did not expect the decline to be as serious as it has become and he does not expect the recovery to be as rapid as it will be. He panicked.

    The idea that the markets could not sort out winner and losers is wrong. The idea that loses on Wall Street will freeze main street is false. The connection between the two streets is minor rather than major. Of course, credit is getting tight and the cost of loans is rising. Debt will not decrease until credit becomes expensive. Columbus Dispatch has a story today saying that small businessmen in Columbus are still able to get loans. Many local banks did not invest in sub-prime mortgages. That business is increasing in small local banks is a plus.

    I am not saying that everything is fine. Everything is terrible. A lot of investments are worth much less than their purchase price. This going to be the largest downturn in economic activity since the Great Depression. What I am saying is that a period of terrible is necessary. The recovery in the financial sector can be swift if Bernanke will get some sleep and keep his cool. What is important is that people like Bernanke and Paulson and Obama have a public sector investment plan passed the Congress and ready to go when the first signs of emerging growth appears. That is the time to spend public money.

    The House Republicans (with the help of John McCain) are my current heroes because they are stalling the unnecessary and useless bailout plan of Paulson. Scrap the plan and allow the stock market to follow its natural inclination (yes I own stock and I am not selling any of it because I have a long investment horizon).

    If the politicians want to do something constructive, they can scrap the bailout plan and pass the additional authority to regulate the financial markets requested by the Chairman of the U.S. Securities and Exchange Commission in his Testimony before the Senate Committee on Banking on Sept. 23, 2008.

    W. Raymond Mills
    1006 Oberlin Dr.
    Columbus, OH 43221
    Ph. 614-451-4075

  • Posted by ReformerRay

    Did I pass math this time?

  • Posted by ReformerRay

    Where is my original contribution?

  • Posted by ReformerRay

    Well, heck.

    I did tell about an alternative plan, based on termporarily “parking” toxic assets with a fedral agency, when the owner does not want to sell and does not want the decrease in asset value to show on their books.

    I don’t want to retype it. Imagine it for yourself.

  • Posted by indignant_prole

    Lots of amateurs here: I know plenty of forutne 100 companies that are deeply affected by the reluctance of banks to lend… especially in the project finance realm.

    Bernanke is smart: this isn’t inflationary: they’re trying to not increase the money supply, and that’s why they’re “selling” the junk to taxpayers. It is inflationary in that your dollar is buyng “less”…

  • Posted by jim

    Prole, You’re the amateur idiot here. The Fed has increased its balance sheet by 35% over the past 2 weeks. If you don’t think that’s inflationary, you’re truly a Moron.

  • Posted by JKH


    I guess I wouldn’t describe securities lending as a net extension of credit per se – other securities are swapped back as collateral. There is no net extension of cash, and the size of the Fed’s balance sheet doesn’t change.

    That said, it’s certainly “liquefying” the system apart from the Fed with improved credit quality, which is more to your point, I think. Indirectly the dealers borrowing treasuries have an easier time using them to finance through repo. That said, they’d be backing into their bank credit lines anyway if they couldn’t finance their own collateral on repo.

  • Posted by Nicole Tedesco

    I have been witnessing first hand that capital still exists (indigenous to the United States) for investment, and that these investors want to invest in things worth investing! What I am also witnessing is that these investors want to be a little more directly involved in their investments. Instead of relying on the levels of informational indirection that the current financial system induces, they want a little more of the transparency and control that proximity can afford. The downside for them is that their portfolios are slightly more exposed to specific investments and their risks are a little less spread.

    My current hypothesis is that we are witnessing an evolution (albeit a painful one) in the financial industry more than we are witnessing a breakdown of wealth and wealth creation. (Though the latter is occuring to some extent, the financial system evolution may be having the greater impact across the board.) This is an evolution of information and control–perhaps individual investors are feeling more enabled due to individual education, the empowerment of information technologies and the ability to manage larger social/investor networks. In other words, individual investors may be starting to do for themselves what specialists have been doing for them for a long time.

    It seems that as long as we can avoid damaging inflation, investor wealth will remain intact and investment will continue. The new problem for the potential debtor (whether you need investment capital or a mortgage) is that you need to improve your education, master information technologies and leverage a large social/investment network in order to get what you need. Capital match-making has not and will not go away, it just became harder for the individual investor and debtor. This, I believe, is a long term trend not just for the United States but for the entire world; the United States has been the first to feel its impact because of its culture, structure and place in the world.

  • Posted by bsetser

    jkh — good points, as usual. liquifying the system is a nice image.

    Jim. Please be civil. Technically, you actually are wrong — so long as the fed sterilizes the increase in its balance sheet, the expansion doesn’t need to lead to a monetary expansion. and in this case, the sterilization was done through the sale of t-bills to raise cash for the fed, cash that the fed then lent out. the net result isn’t necessarily any new money creation. in a lot of ways this is analogous to china’s sterilization of the rapid growth of its fx assets, though the mechanism used for sterilization differs.

  • Posted by Fullcarry

    I am not sure I understand the notion that the FED’s balance sheet is limited. The FED can always increase its balance sheet by monetizing more debt. Where is the limit?

    In fact, in the face of the AIG cash infusion the FED’s balance sheet has in fact expanded:

    Of course, the treasury started issuing T-bills last week to help drain the excess liquidity the FED’s AIG assistance had generated. But the fact remains the FED can always increase its balance if it chooses.

    If my reasoning is faulty I would appreciate a response. Thanks.

  • Posted by ReformerRay

    The FRB press release fo Sept. 26 (yesterday) talks about “temporary recroprical currency arrangements (swaps)” with other Central Banks amounting to 290 billion dollars, to be used by the central banks to provide liquidity to short-term U.S. dollar funding markets.

    I assume “recroprical” means the U.S. received other nations currency equal in value to $290 billion. If that is the case, this infusion of money would not necessarily show up on the balance sheet of the FRB, would it?

    My impression is that these guys have all kinds of tricks and resources and that they can supply whatever liquidity the short-term dollar market needs.

    If the private banks withdraw from this market, the Central Banks can and apparently have, stepped in. So where is the liquidity crisis?

  • Posted by Nicole Tedesco

    I could be wrong. See here [] for commentary on lag–my observations can easily be a result of the fact that I have just not yet been exposed to lagging effects of the current crisis.

    Other possibilities: Are we seeing cutting edge indicators of the very long term drop of the very concept of “cash” itself? (Assume distant future in which, because of advances in technologies, the cost of manufacturing anything converges to zero.) Are we witnessing the effects of the weakening of the concept of “nation”? Something is telling me what we have been witnessing over the last couple of decades is something unlike anything we have witnessed in the past. Can’t quite put my finger on it though…

  • Posted by artichoke

    There are two ways of increasing money available to banks:

    1. Bernanke prints it.
    2. Treasury gives it, taxes the taxpayers for it.

    The two are equivalent, except that in the second case the burden is put squarely on the taxpayers. In the first, we “share the wealth” with those who hold USD, e.g. China.

    The massive resistance to printing, for the past year from Bernanke, has been to put all the burden on the taxpayer, sterilizing at his expense. The Paulson plan is more of the same, except in the form of gifts to banks rather than loans.

    The taxpayer has suffered as his pocket has been picked.

    Now Bernanke has no choice and indeed he is printing. He should keep printing, he is doing the right thing.

    And Congress should do nothing in a rush. I’m not opposed to helping the banks increase capital, in exchange for common or preferred equity at current market prices. This should be considered. But the current proposals are bad and too rushed, this is no way to do business. It’s Bernanke’s job to handle things in the mean time, and the market can have confidence that he is providing liquidity to those solvent banks that need it.

  • Posted by Austrian Banker


    The second alternative is *not* correct. The treasury BORROWS the money from the MARKET, postponing the pay off until such time revenues make up for it (ie. taxation).

    That very money, which is right now sitting around and providing some oil in the real economy.

    When the state entices this money to leave money market funds etc, then $700 billion are effectively wiped out from the good economy and handed to the bad economy (the bankers).

    That is the sucking sound of an economy going to permasleep.

  • Posted by Judy Yeo

    aww, missed the londonbanker and rebeleconomist crossfire with the other commentators…


    some academics spend a lifetime waiting to be proven right, guessing that roubini has just struck the economic version of the vegas one arm bandit… not much point being right if you don’t get the jackpot 😉


    saw some of your comments – the accounting, I wisely leave to the experts, after all, they are paid for that. as opposed to me.

    safe to say- some of those assets are more likely to be “liabilities” though classified as assets- what is of concern is how they will account for (the unlikely, at least according to industry experts) decrease in value of the purchased crap, sorry, distressed assets? Amortization?

  • Posted by ReformerRay

    “this is a real crisis”. Based solely on some numbers. Amount of money lent out by Central Banks, IMF AND FRB.

    Comparing apples to oranges. If the money is lent overnight, the Fed has it back the next day to lend it again.

    Need to compare the total amount of lending that is not recovered within a short period of time (as in the IMF lending). Could be a very small number.

    The websites of FRB and the European Central Bank give the story of the increase in overnight lending throughout the world. Central banks have stepped in to provide liquidity where the private banks have withdrawn. Any reason why the Central Banks cannot continue to do what they have been doing for the past week?

    I think we have been suckered by Bernanke crying wolf (entire system will collapse) when there is no wolf at the door. My hope is that no bill will be passed tomorrow and the next day so as to show that the economy is not about to collapse.

    Alas, the desire of Congress to go home will override good sense.

    My consolation is that any bill that is passed can be revisited later.

  • Posted by Dave G

    Can anybody say with any assurance that $700 billion of cash – not loans – is readily available for the government to use? The banks do not have the money, redemption of money market funds will simply lead to more demands on the system for liquidity. Sovereign wealth funds ? – they already own the existing bonds, why would they want more?

    I don’t get exactly where is the source of these funds, assuming this plan is not a fig leaf for monetizing $700B of new debt.

    Any ideas?

  • Posted by RebelEconomist


    Regarding the effect of the reciprocal swap arrangement on the Fed H.4.1 report, take a look at my blog posting:
    including the comments.

    I think that the swap itself does not appear on the H.4.1 report, which is, after all, entitled “factors affecting reserve balances”, rather than being the Fed’s complete balance sheet.

  • Posted by RebelEconomist

    Dave G,

    The banks will have the money after the TARP buys their crud. In theory, the banks could spend the proceeds on more crud in an attempt to earn a higher return, but I think that the US authorities would take a dim view of such behaviour!

  • Posted by Edwardo

    Someone wrote:

    “The Fed can always print money on a grand scale. But if it does this, the international funding that the US needs will stop. Thus, the Fed is limited in a very real way. And it is burning through its current balance sheet at a terribly fast pace. As Brad Setser says… […]”

    Whatever the Fed’s balance sheet may show today, absconding with untold billions via a massive disinformation campaign/putsch will not remotely resolve the problem. Why? Because the problem exists at the heart of the global fiat based money system that relies on growth that is no longer possible in a world of finite resources.

    I submit that what we are witnessing now is a secular change of epic size. Peak debt, the death of which we are currently witnessing came about as a way to make something from nothing. It is no accident that the reach for outsized yield that is at the heart of the advent of all the lethal financial instruments of mass destruction came about after this nation was stripped of its industrial base.

    The global Great Depression, which will be the greatest experienced by mankind post enlightenment, is underway and the U.S., particularly Wall Street, is the epicenter of the initial quake. This bailout, as obscene as it is, one perpetrated by rubes and criminals and abetted by cowering fools has as much chance of arresting the onset of the well underway U.S. economic contraction as a one legged pygmy does of bringing down a rogue elephant with a bent thumbtack.

  • Posted by artichoke

    Austrian Banker, you’re right.

    If this passes, I think I will move to China. Seriously.

  • Posted by Howard Richman


    Thank you for your welcome back comment and for sharing with me your posting about my writing. Too bad you didn’t mention our book when you were criticizing it. Trading Away Our Future is readily available (see ).

    Some day, you will have to reread Adam Smith to find out what he is really saying about mercantilism. He is saying that mercantilism hurts the world economy as a whole. To him, mercantilism was the concept that accumulating gold should be the goal of economic policy. He was advocating, instead, that the wealth of a nation is its production, not its stock of gold.

    You should also look at what Hume actually argued. He said that an inflow of gold drives up prices in the surplus country and drives prices down in the deficit country which tends to correct the trade imbalance.

    Hume was correct about the mercantilism of his day, but did not anticipate modern mercantilism. In fact, if the goal of the gold mercantilists were to build their industry (not their gold hoards), they could have practiced the same system that the modern mercantilists practice today by using the gold obtained from trade to buy assets in the trade deficit country.

    It’s also too bad you haven’t yet checked Peking University Heng-Fu Zou’s 1997 mathematical treatment of mercantilism, “Dynamic Analysis of the Vineer Model of Mercantilism” (Journal of International Money and Finance). So you would have realized that your consumption argument was a short-term argument. Indeed, Chinese mercantilism enhances present US consumption, and reduces present Chinese consumption. But Zou demonstrated mathematically that the modern form of mercantilism results in long-term gain in consumption for the practicing country, even though in the short run it has less consumption.

    The huge factor that you missed entirely in your analysis is the effect of mercantilism upon investment opportunities in the practicing country and the victim country. By holding its exchange rate approximately 40% below where it should be, China makes its products 40% less expensive to American consumers and American products 40% more expensive to Chinese consumers. As a result China gets investment while the United States does not, making Chinese products even less expensive to American consumers, compared to American products.

    Seeing as the current US investment slump is causing our economy to go into economic stagnation with the definite possibility of an economic talespin, you really should look into the factors that are causing it.

    Howard Richman

  • Posted by Twofish

    The problem isn’t the banks.

    If the banks go into survival mode they will (and in fact are) pulling money out of the commercial paper market. If the commercial paper market dies, then you will start seen a huge number of companies starting to fall from the skies.

    Companies have gotten into the habit of borrowing short term to fund long term expenses. If you can get money at 1-2% with a 30-day loan, you aren’t going to borrow money at 6-7% with a 30-year bond. The theory is that as one loan expires you can borrow more money and rollover the short term loan. This all works….

    Until you run into a situation in which no one is willing to loan money at any price. At which point companies suddenly go broke. And then the credit-default swap bomb goes off, because when a company goes under, then all of a sudden billions of dollars of payments are triggered….

    Right now banks are not lending and the *only* thing that is keeping the short term credit markets from collapse are massive purchases by central banks. They are going to run out of money in about a week or two. If you can’t get the credit markets to start lending, then you are going to see massive corporate bankruptcies and defaults when they are unable to rollover their short term financing. The world economy is going to shut down.

    We are in the financial equivalent of the “Cuban missile crisis” where one wrong move and the whole financial system blows up. No one right now is thinking more than one or two months ahead because if we don’t get through the next few days, it doesn’t matter.

    The financial system is in the process of crashing and the reason for bailout package is to make sure that there is this huge $700 billion pile of feathers to absorb the impact of what is about to happen. Everything you’ve seen, that’s just a prelude. It’s going to get a lot worse.

    The good news is that something is going to get done, and we’re probably going to make it through all of this…. I’m a little surprised and amazed that we’ve gotten to this point in one piece.

    So I’m an optimist. :-) :-) :-)

  • Posted by emoboy

    Hey, My pictures of my new emo hairstyle