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Do not doubt that this is a real crisis: more on Fed’s balance sheet

by Brad Setser
September 30, 2008

My colleague at the Council on Foreign Relations, Paul Swartz, has graphed the shift in the composition of the Fed’s balance sheet. The Fed has extended a lot of credit to the financial system — and supplied even more liquidity by letting the investment banks borrow some of its Treasuries.

fed-balance-sheet.PNG

Note: I updated the graph in response to the comments below. The CFR’s web technology does not currently allow the graphs to be expanded. More of Paul Swartz’s graphs — including a new graph on the impact of the house vote on various financial markets — can be found on the CGS website.

The amazing thing about this graph is that it doesn’t capture all the credit central banks extended to the financial system last week (Paul used the weekly average numbers, not the data for the end of the week) or the new credit that will be provided by the programs that were expanded today. Those programs should allow the Fed to increase its lending even further.

This graph also does not capture the $500 billion the Fed has lent to other central banks through various swap lines — dollars that other central banks have lent to their own troubled institutions.

Right now, the world’s central banks are truly providing the short-term financing to host of troubled banks that are having trouble raising funds in the market. Laurence H Meyers of Macroeconomic Advisers notes:

“The liquidity measures are a stopgap … You’re funding the banks’ balance sheets, but nobody wants to lend money to them because they’re all afraid of insolvency.”

That sounds right to me. Right now, the US is relying a bit too heavily on the Fed to keep this crisis from spiraling truly out of control. That avoids hard political choices –notably hard choices about how best to recapitalize the financial system — but it also creates some long-term risks for the Fed.

I fully recognize the risk that the US government eventually could flood the market with unwanted Treasuries, driving interest rates up — and thus there are limits on how much support the US government can supply the financial system. But as of now, there isn’t much evidence that there is a shortage of demand for Treasuries — indeed, recent market moves suggests a shortage of Treasury bills in the market rather than a surplus. And that certainly is not because the US government has been scaling back its bill issuance.

By my calculations, the supply of marketable Treasury bills not held by the Fed –i.e. the bills actually in the market — increased from $738.4 to $1200.2b between August 2007 and August 2008. That is a net increase in supply of around $462b. The Treasury was issuing more bills, and the Fed was reducing its holdings to “sterilize” or offset the credit it extended to private financial institutions. The US data on foreign holdings only runs through July, but it suggests that foreign central banks only snapped up $50b or so of this increase: central bank holdings of bills rose from around $180b to $232b. There was a huge surge in private holdings of Treasury bills, with the stock in private hands nearly doubling in 12 months.

And that was before the big surge in bill issuance in September.

Yet judging from market yields, there is no shortage of demand for T-bills despite the huge increase in supply — an increase in supply that is primarily in private not central bank hands. The New York Times reports:

Yields on three-month Treasury bills shrank to just 0.29 percent on Monday, a sign that investors were fleeing from any kind of risk, even if it meant earning a return far lower than the inflation rate.

The outstanding stock of notes (coupon paying bonds with a maturity of between one and ten years) not held by the Fed rose by $280b from August 2007 to August 2008, so there wasn’t just an increase in bill supply. And again, there doesn’t seem to be a shortage of demand. Here though central banks have been big buyers.

One other interesting side note: I would estimate that foreign central banks now hold well around 70% of the outstanding $2265b stock of marketable Treasury notes not held by the Fed. To get that estimate I have to assume that central banks account for most of the $260b or so of private purchases of Treasury bonds over the past year bringing their , and that central banks hold few bonds over ten years and few TIPs — so total central bank holdings of notes are in $1650-$1700b range. Central bank holdings are actually fairly concentrated in certain market segments.

84 Comments

  • Posted by RebelEconomist

    It seems to me that we are being presented with a false dichotomy today, in an attempt to bounce us into supporting the Paulson plan. Either pass what is on offer, which just happens to involve a free gift to the bank shareholders and junior creditors, or face economic collapse. I don’t buy it.

    Just nationalise banks as they fail, and then work out later how to dispose of them. The shareholders, and probably junior creditors, should face the first losses before any call on the government. That way minimises both public expenditure and moral hazard.

    In the time that the Paulson plan has been debated, several banks in Europe have got into difficulty, been nationalised, remained open for business, with no panic. It must be possible to approve such a scheme for the US as quickly as passing the existing bill.

    And the wider the spreads between private and government credit, the stronger the case for nationalisation.

  • Posted by James Kroeger

    It is my understanding that the Fed obtains securities on its balance sheet by simply paying for them with money that is created out of thin air with a keystroke.

    I’ve spoken to two Fed economists who assured me that no account of limited size is debited when the Fed buys securities during Open Market Transactions. It is ‘new money’ that did not exist prior to the moment when it was keystroked into existence.

    If this is true—I have NEVER been able to find an economist who would deny that it is—then why is it that anyone is suggesting that the Fed could ‘run out of money?’

    Is it not true that if the Chinese were to try to sell all of their dollar assets for Renminbi, interest rates would be relatively unaffected if the Fed were to simply buy them all up?

    Can anyone direct me to some factual information that will either confirm or refute the above assumptions?

  • Posted by KnotRP

    Twofish says: I normally dislike Ayn Rand, but I’m starting to think about “Atlas Shrugged” and perhaps it would be a good thing if all of the supposed “evil Wall Street banksters” just went on strike for a week, so that people can see the wonderful utopia that would result without financial markets.

    —–

    A well run bank is a blessing.
    A looting operation disguised as
    a bank is a curse.
    Main Street (where original wealth is created) can suvive without Wall Street, particularly when
    it’s looting more than banking.

    It’s ironic that Main Street is shrugging at Wall Street right now, yet you invoke the metaphore in reverse, as if that’s a credible threat. Small regional banks would spring up in the sunshine left after the removal of diseased growth….life will go on, people will adjust.

    First, sort out the good from the bad.
    Then, throw capital at the good.

    Ready, Aim, Fire….not Ready, Fire, Aim.

  • Posted by Michael

    The very fact that the 62% increase in Treasuries put into the markets in one 12 month period was performed in a panic-driven process and the purchases were made in a panic-driven process is perhaps the best indicator that the purchases don’t reflect any long-term commitment to Treasuries.

    Once the panic subsides the selling will begin, and unless the sense of panic can be successfully re-created at regular intervals, will turn into a rout from this new form of toxic debt.

  • Posted by Dave C..

    http://www.newsweek.com/id/161649/page/2

    So are China’s banks at risk of contagion? China’s banking sector is “one of the healthiest in the world,” says Jing Ulrich, Chairman of China Equities at JP Morgan. Chinese banks are awash with liquidity, sitting on bank deposits from thrifty savers totaling $7 trillion. Banking analysts were not alarmed that China’s two biggest retail banks had $280 million worth of exposure to bankrupt Lehman Brothers. Nor is there much sign of the domestic mortgage market triggering an identical, system-wide collapse. Although home ownership levels are as high as 80 percent in some cities—a sign of China’s passion for property—many homebuyers pay cash. Ulrich says mortgage-holders seldom buy beyond their means, so a wave of defaults is unlikely, even in a slowing economy.

  • Posted by Twofish

    Jehu: I cannot believe this is true. I am more than sure most here are aware that this entire crisis rests on the inability of the consumer sector to absorb any more new debt.

    I hate to use too many analogies, but you have a patient that has a really horrible lifestyle. Eats fatty food, smokes, doesn’t exercise, etc. etc. One day that person has a massive heart attack.

    At that point the picture changes, and we are in a situation where people are frantically shocking the patient, doing CPR, and just basically keeping things alive. The global economy is literally on life support right now.

    That’s basically the situation we are in. Paulson’s plan is not intended to solve any of the root problems of the economy, any more than putting someone in ICU is intended to make someone give up smoking.

    It’s intended to prevent a massive economic meltdown. Now maybe the heart attack patient will leave the hospital and change their ways or maybe they won’t. Right now, I don’t care, because if the credit markets seizes up, you are going to have massive bankruptcies throughout the entire economy.

    Kroger: I’ve spoken to two Fed economists who assured me that no account of limited size is debited when the Fed buys securities during Open Market Transactions.

    This is true, but right now the Fed is massively *selling* Treasury bonds and then using the cash raised to buy short term commercial paper. Once the Fed and Treasury depletes its stock of bonds then it has no more cash to do anything. The only people that can provide the Fed with more Treasury Bonds is Congress which is where is where to get back to Paulson’s proposal.

    Once the Fed runs out of Treasury Bonds and if Congress doesn’t authorize the issuance of new bonds, then *GAME OVER*. The Fed at that point has no ability to prevent a general economic collapse.

  • Posted by obey

    Dave C., thanks, that’s interesting. They then seem to have a strong funding base. But at some level the Chinese banks are directly or indirectly sitting on dollar denominated assets- principally treasuries – which will tank if interest rates rise or the dollar falls. Or am I wrong?

  • Posted by Twofish

    KnotRP: Small regional banks would spring up in the sunshine left after the removal of diseased growth….life will go on, people will adjust.

    I find that people who are most optimistic about what life is like after an economic meltdown have never really lived through one. Yes, people will adjust. After all, people did live through the Great Depression and World War II, and even worse things. I find it amazing the hell that people have been able to go through. But I’d rather not take the journey.

    KnotRP: First, sort out the good from the bad.

    If you are in a burning building you do not have time to do the sorting, because if you wait, everything will burn to the ground. Once you start having bankruptcies, then previously good loans will turn bad, and you will have a cycle that won’t stop until everything is leveled.

    Michael: The very fact that the 62% increase in Treasuries put into the markets in one 12 month period was performed in a panic-driven process and the purchases were made in a panic-driven process is perhaps the best indicator that the purchases don’t reflect any long-term commitment to Treasuries.

    They don’t. No one cares if the US defaults in 2030. Right now people are just rushing into Treasuries so that they don’t get soaked if the economy falls apart next month, because people are facing the very real possibility that there will be no economy next month.

  • Posted by KnotRP

    Twofish says: find that people who are most optimistic about what life is like after an economic meltdown have never really lived through one.

    You are hopelessly confused if you think I’m optimistic. I just think you cannot unbreak an egg.
    You seem to think you can, if you hurry.

  • Posted by KnotRP

    Twofish – your burning building analogy presumes the arsonist hasn’t already carted off anything and everything worth saving…..that’s where we differ.
    The water now has more value than what you would apply it to…

  • Posted by CG

    Twofish: Once the Fed runs out of Treasury Bonds and if Congress doesn’t authorize the issuance of new bonds, then *GAME OVER*. The Fed at that point has no ability to prevent a general economic collapse.

    What if Fed prints dollars, uses said dollars to buy Treasury Bonds from China, China converts dollars into RMB – ie debase the dollar, revalue RMB, begin rectifying global imbalances, etc

    Would require quite the coordination, but I believe a debasing of the dollar played a role in bringing an end to the Great Depression, no? I dont think this scenario would cause a “general economic collapse”, but no doubt there’d be significant temporary pain in the adjustment…

    (Long-time reader, first-time poster)

  • Posted by flow5

    It would seem that somewhere, somehow, if total net debt (not just Federal Debt) keeps rising faster than production (Real-GDP), the burden of interest charges at some point now indefinite and unknown, but nevertheless real, will become too great to carry.

  • Posted by flow5

    Any deficit, by definition, creates a demand for loan-funds. The larger the deficit, the higher interest rates will be, or the less they will fall.

    Any given deficit should be evaluated in terms of: (1) the size of the deficit in the context of the size of future deficits, and the accumulated debt relative to the means and costs of financing the whole: (2) how the deficit is financed: (a) from savings or (b) commercial bank credit, i.e., newly created money; and (3) the purpose for which the deficits are incurred.

    Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security for now is not include in the above list since only a very small proportion of social security benefits are financed from non-social security taxes.

    From an economic standpoint, only interest is “untouchable”.

    If current projections of Federal Deficits materialize in this, and the next few years, interest rates (both long and short-term) will be driven up sharply by the increased demand for loan funds. I.e., any recovery in the economy will present a “Catch 22” situation. An upturn in the economy will add increased private demand for loan funds to the insatiable demands of the Federal Government.

    The consequent rise in interest rates will effectively abort any recovery.
    Raising taxes to accomplish a reduction in the deficit would be counter-productive.

    Most of this debt is short-term. Combine this with the factor with the constant roll-over of some of the long-term debt and it becomes obvious that the burden of higher interest rates will be compounded. The burden becomes a function of the major portion of the debt, not just the current deficits.

    The burden, in fact, becomes exponential. In other words, if the trend is not stopped, the debt inevitably has to be repudiated.

  • Posted by flow5

    Those who are wont to minimize the ill effects of the deficit are prone to compare the size of the deficit with nominal GDP, as if the volume of nominal GDP were independent of the size of the deficit. Unprecedentedly large deficits “absorb” a disproportionately large share of nominal GDP

    Present deficits are unprecedented no matter how measured, and the past gives us no reliable guide to the future effects of deficit financing, beneficial or otherwise.

    To appraise the effect of the federal budget deficit on interest rates, it is necessary to compare the deficit, not to GDP, but to the volume of CURRENT SAVINGS made available to the credit markets. The current deficit is absorbing about 24% of gross savings.

    The more alarming aspect of the deficits is not the effect on interest rates but the effect of high interest rates on the level of taxable income and the volume of taxes required to serve a cumulative debt now exceeding $9.7 trillion.

    Both high interest rates and high taxes induce stagflation, thus eroding the tax base and increasing the volume of futures deficits

  • Posted by flow5

    It should be recalled that the charges on debt are related to a cumulative figure; and since the multiplier effects of debt expansion on income, the ingredient from which the charges must inevitably be paid, is a non-cumulative figure, it would seem that the time will inevitably arrive when further debt expansion is no longer a practical or possible expedient, either to provide full employment or to keep debt charges with tolerable limits.

  • Posted by flow5

    The significant economic purposes for which a debt was contracted, or the manner in which it was financed, is of inestimatable value in evaluating it’s impact.

    For example if the debt was acquired to finance the acquisition of a (new-security), the proceeds of which are used to finance plant and equipment expansion, rather than the purchase of an (existing-security) to finance the construction of a new house, rather than to finance the purchase of an existing one (as will Paulson’s planned $700 bill bailout), or
    to finance (inventory-expansion), rather than refinance (existing-inventories).

    The former types of investment are designated as “real” as contrasted to the latter, which constitute “financial” investment (existing homes). Financial investment provides a relatively insignificant demand for labor and materials and in some instances the over-all effects may actually be retarding to the economy. Compared to real investment,it is rather inconsequential as a contributor to employment and production. Only debt growing out of real investment or consumption makes an actual direct demand for labor and materials.

  • Posted by Michael

    Twofish- “It’s intended to prevent a massive economic meltdown. Now maybe the heart attack patient will leave the hospital and change their ways or maybe they won’t. Right now, I don’t care, because if the credit markets seizes up, you are going to have massive bankruptcies throughout the entire economy.”

    You’re absolutely right, and any discussion not accounting for this fact is wasteful.

    The problem is not the past case history showing how the finance industry got sick, nor even the current necessity of immediate radical medical treatment.

    The problem is just how different life is going to be from here on, since it is now apparent that the patient cannot survive going forward (after stabilization of the immediate crisis with open-heart surgery) without a permanent pacemaker of government subsidy for excess credit creation. Any return to an income/savings-based equilibrium economy are henceforth financially and politically unacceptable, as that would require the elimination of 70% of the finance industry and a drastic drop in our GDP level.

    Thus, the emergency medical intervention morphs into a permanent medical life-support process for the finance industry. You are correct that the American and World economies as we know them have become dependent upon the finance industry for excessive credit to conduct the level of business to which we have become accustomed. We are – not as an intentional conspiracy, but as the outcome of ordinary capitalist evolution – now hostage to the excesses of the finance industry, and if we don’t subsidize them immediately and permanently they will drag us straight to Hell with them. You got that right.

    But, do you understand why now is precisely the time that most of us would like to at least think the forbidden thought that maybe there will be no end to this kind of kidnapping unless we consider saying no?

  • Posted by Roland

    If nothing else, a protracted crisis would help put the “political” back into political economy.

    Besides, it’s sort of fun to watch Twofish’s complacency openly give way to panic.

    As for crisis, a lot of “plain folk” actually do have the vivid experience of unemployment, being broke, not being able to do what one wants, reduced expectations, etc.

    That’s why we’re not as worried as some of Twofish’s beloved shrugging tekkiecrats.

  • Posted by Twofish

    Roland: Besides, it’s sort of fun to watch Twofish’s complacency openly give way to panic.

    It’s actually rather curious since I do think that the plane will miss the mountain, but it’s heading in a direction that has me very worried.

    Roland: As for crisis, a lot of “plain folk” actually do have the vivid experience of unemployment, being broke, not being able to do what one wants, reduced expectations, etc.

    Unless you are from Argentina, Russia, or Mexico or are over 70 and lived through the 1930’s, you probably haven’t had experience with the type of calamity that we are looking at.

  • Posted by Twofish

    CG: What if Fed prints dollars, uses said dollars to buy Treasury Bonds from China.

    The trouble is that to buy something you have to have a seller, and right now very few people are willing to sell Treasury bonds, and it’s not going to stop the current panic, and probably would make it worse.

    In the long run, the government could assume the bad debt and then inflate the debt away. It is a bad option, but it’s an option.

    KnotRP: You are hopelessly confused if you think I’m optimistic. I just think you cannot unbreak an egg. You seem to think you can, if you hurry.

    The curious thing about all of this is in some ways I think that McCain is right. The US economy *is* fundamentally sound. That’s why it would be a stupid/tragic thing if this crisis gets out of hand and causes some real economic damage (which interestingly enough, it hasn’t.) One thing that is painful about reading the history of economic crises is what a senseless waste it is when things blow up for no good reason.

    So the fact that I’m panicky is actually a flip side to my normal complacency. There’s no point in getting excited if you think you are doomed and there is nothing that can be done about it. But I think that there is. The decisions that get made in the next month will determine the course of history for the next generation.

  • Posted by James Kroeger

    “Now maybe the heart attack patient will leave the hospital and change their ways or maybe they won’t. Right now, I don’t care, because if the credit markets seizes up, you are going to have massive bankruptcies throughout the entire economy.””

    So why are no economists proposing bypass surgery? Congress could allocate $1-$2 trillion dollars to (A) finance a huge increase in federal spending, and (B) capitalize a Taxpayers’ Bank to address all liquidity concerns re: Main St.

    This Taxpayers’ Bank could provide abundant loanable reserves to small businesses and non-financial firms and even households, e.g., mortgage re-financing. This would effectively insulate Main St. from the chaos of Wall St. The patient’s heart could then be repaired through creative destruction.

    Think about it. If a trillion dollars of govt. spending were injected into the economy, Main Street would likely experience an economic boom at the same time that the financial sector is collapsing utterly.

    Trillions of dollars of paper wealth would be written off. Then, after the wave of bankruptcies finally subsides, the survivors would be in a position to start lending again. After the crisis has passed, Congress could then re-privatize the Taxpayers’ Bank, if that was considered desirable.

    Benefits: (1) Main Street largely protected from the Wall St. carnage, (2) moral hazard returns to the private banking sector, (3) the problem of ‘toxic paper’ is cleansed from the system, and (4) the whole thing gets resolved in a year or so.

    Ready to sign on, Brad?

  • Posted by Michael

    Twofish – “Unless you are from Argentina, Russia, or Mexico or are over 70 and lived through the 1930’s, you probably haven’t had experience with the type of calamity that we are looking at.”

    Nope, I missed the Depression, having been born in the middle of WWII. Or did I?

    One of the effects of the Depression was the elimination (through the “calamity” that you propose we fear) of insolvent banks, over-leveraged stockholders, and creditors with zero judgement everywhere. Businesses and worker/comsumers stopped using cheap credit to speculate and “buy on the installment plan” as they had prior to the Crash.

    Definitely hard times for the 20% unemployed (but good times for the 80% who were employed and saw their real wages rise faster and higher than ever before or since). Also hard times for those who had taken on more debt than they could afford.

    But the aftermath of the Depression-level credit crash was not the “calamity” you claim it must be – the whole country did burn to the ground and the economic body did not die.

    Rather, a whole generation learned a critical lesson and returned to the income/savings model they had been using to create wealth (slowly) before they went crazy and used leveraged debt instead to try to create wealth (quickly). By the time WWII came along, we were at the lower but stable equilibrium economy that we would have been at if the 1920 credit excesses had never occurred in the first place.

    During the war, consumption and borrowing were constrained both by the rediscovered habit of THRIFT as well as by government rationing and other economic controls.

    After the war, there was the highest level of household savings per capita EVER in the U.S. I grew up in the period from 1945-1966 when all that accumulated saving was spent without excess credit creation and I can tell you the result was the most stable and consistent non-inflationary growth I have ever seen. Thus, I am a direct beneficiary of the “calamity” of the Great Depression.

    However, when Americans had spent their 20-years worth of accumulated savings, and a new generation (mine) that hadn’t experienced the Depression took over, a new cycle of excessive credit growth began, leading to the debt-fueled trade imbalances, permanent fiscal deficits, and inflation of the period from 1967-1979. The “Golden Era” turned into “Stagflation.”

    I DID live through the crash of the 1982-1983 recession (which, if you didn’t, I can tell you felt like a Depression to the 10% unemployed and all the closed businesses). Thanks to the Fed taking a counter-cyclical stance under Volcker, a crash was permitted, and once again the speculators and leveraged debtors (and many banks) were cleaned out. Were you there for that one?

    The result? The so-called “Great Moderation” from 1984-2006 when, even with growing excesses of leveraged debt and speculation again running wild (to the point of $62 trillion in speculative gambling with other people’s money) and with a pro-cyclical Fed feeding the fires, we managed low unemployment with little inflation and few recessions until the inevitable reckoning. We only got to live out that fantasy as long as we did because of the cleanout from Crash of ’82.

    Why the history lesson? Because, if you don’t accept the necessary healing role of credit contractions (even the more abrupt and severe ones, which are the result of greater excesses and denial) as one of the healthy parts of the business cycle, I don’t believe you understand the business cycle.

  • Posted by Twofish

    Michael: I DID live through the crash of the 1982-1983 recession (which, if you didn’t, I can tell you felt like a Depression to the 10% unemployed and all the closed businesses). Thanks to the Fed taking a counter-cyclical stance under Volcker, a crash was permitted, and once again the speculators and leveraged debtors (and many banks) were cleaned out. Were you there for that one?

    Yes, and one part of the that effort was the establishment of the Resolution Trust Corporation which cleaned everything out.

    Michael: Why the history lesson? Because, if you don’t accept the necessary healing role of credit contractions (even the more abrupt and severe ones, which are the result of greater excesses and denial) as one of the healthy parts of the business cycle, I don’t believe you understand the business cycle.

    Precisely, but the danger is that things can go off the rails, and you end up with the type of massive contraction that you see in October 1929 or the type of bloodshed that you see in Latin America. The type of thing that doesn’t just last a year or two, but destroys an entire generation.

  • Posted by KnotRP

    Twofish says: The curious thing about all of this is in some ways I think that McCain is right. The US economy *is* fundamentally sound.

    So eight plus years of flat real wages combined with record personal debt, record low housing equity, record low personal savings, poor job creation, and offshoring of many job functions, and you think the economy is fundamentally sound?

    I guess we’ll have to agree to disagree.

  • Posted by DAve

    FDIC insures depositors against bank failures. It provides in its present state insurance for up to $100K each depositor.

    The latest brilliant idea is to up the limits from $100K to $250K each depositor.

    FDIC DOES NOT HAVE ENOUGH MONEY TO COVER THE DEPOSITS IT ALREADY HAS AND NOW THE PLAN IS TO INCREASE ITS (WHICH MEANS OUR) OBLIGATIONS AND EXPOSURE ALMOST THREEFOLD.

    Check out the amount of money FDIC actually has versus how much it will have to pay if only a few more banks fail. It doesn’t even have 1/10th of what it could need. And many more banks WILL fail guaranteed.

    This seems like just another back door way to trick us into bailing out big money players.

    Our representatives are not supposed to be our enemies

  • Posted by KnotRP

    DAve…the way it works, see, is ya have this $250K bazooka in your pocket, see….so having a bazooka means you won’t have to use it…
    oh, I used that one already? Hold on a sec, while I check my notes…

  • Posted by Twofish

    KnotRP: So eight plus years of flat real wages combined with record personal debt, record low housing equity, record low personal savings, poor job creation, and offshoring of many job functions, and you think the economy is fundamentally sound?

    Yes. Because corporate profits are huge and while median wages are flat, wages and salaries for the people in high incomes have skyrocketed. Over the last eight years, the US economy has generated a ton of wealth, it’s just been concentrated at the top 1% of the population.

  • Posted by Jehu

    Twofish: I hate to use too many analogies, but you have a patient that has a really horrible lifestyle. Eats fatty food, smokes, doesn’t exercise, etc. etc. One day that person has a massive heart attack.

    Two fish, I think the problem is a lot less complicated than appears in this forum. All this analogy about mucking around in the E.R. trying to save the patient is fine.

    But financial system crisis is not the patient, it is part of the disease process – is it not?

    The object is prevent the disease from doing more damage to the real patient: ordinary Americans, aka, Main Street.

    If the plan were to contain the disease, and then eliminate it, how would your ideas change?

  • Posted by Jehu

    Which brings us to the real issue: the disease is not being contained and eliminated.

    It is being treated as if it were the patient.

    Meanwhile, the real patient has no idea what is about to happen.

  • Posted by adiemuso

    test

  • Posted by a

    Excuse me if this has already been commented on, but is this the dynamic we are seeing now that the Fed has used up its balance sheet?

    The banks need dollars. The Fed gives them dollars. To get those dollars, the Fed sells Treasuries. To buy those Treasuries people are selling dollar assets, such as hedge funds and money-market funds. Money-market funds then have less money to invest in commercial paper. Banks are able to raise less money via cp. Companies are able to raise less money via cp, and thus turn to their credit lines at banks. So banks need even more dollars. Am I missing something?

    Maybe this is called “pushing on a string” or “liquidity trap” – I don’t know. But if the Fed has really used up its balance sheet, having the Fed lend money to banks with its right hand while its borrowing money via Treasuries with its left, will not help over-all dollar liquidity at all.

  • Posted by RebelEconomist

    a,

    What you are missing is that someone has to buy non-treasury dollar assets. That is the Fed. The Fed is buying loans – aka lending money – which are collateralised with the banks’ dodgy assets (which, pending the TARP, remain on their books).

    Pushing on a string is something different. That occurs when, because the demand for money, being a relatively risk-free asset, is so huge that increasing the money supply does not increase spending. Instead the additional money is readily held. I do not think we have reached the point yet where the Fed are expanding the base money supply (ie lending without selling treasuries), but with all the schemes going on, it gets a bit hard to tell!

  • Posted by Twofish

    Jehu: If the plan were to contain the disease, and then eliminate it, how would your ideas change?

    I honestly have no idea what long term changes the US has to make in its economic structure, and what happens next will involve a lot of debate and heated discussion.

    However, in order to have that discussion we have to get the economy into some shape where we can put it on autopilot for a few months and think and discuss what to do next. The problem with the current situation is that if you “do nothing” then you going down exactly the same path that “do nothing” did in early-1930.

  • Posted by Jehu

    “The problem with the current situation is that if you “do nothing” then you going down exactly the same path that “do nothing” did in early-1930.”

    Exactly. The US had to direction to take in the 30s:

    1. Inflation
    2. Reduce the work week

    Washington chose inflation – which worked for six decades, but now has foundered on the rocks of consumer debt.

    Perhaps this time we could try the other, and let the creidt market unwind in a way which doesn’t hurt ordinary people.

  • Posted by Twofish

    a: The banks need dollars. The Fed gives them dollars. To get those dollars, the Fed sells Treasuries.

    What happens is that to get those dollars, the Fed takes as collateral securities or loans that the banks have and then issues cash to the banks. This is where the Fed prints money (literally). You give the Fed something of value as collateral, the Fed shows up with an armored truck full of green paper.

    For this to work, the banks have to give the Fed something of value. Some security or loan or treasuries. If the banks have nothing of value to give to the Fed or anyone else, they can’t get dollars to loan out, and so they start cutting back on the dollars that they have.

  • Posted by flow5

    “Great Modernization”

    Hardly, the DIDMCA created the legal framework for the addition of 38,000 more commercial banks to the 14,000 we already had, and in the process, the abolition of 38,000 intermediary financial institutions.

    The intermediary financial institutions effected were the nation’s savings and loan associations, mutual savings banks, and credit unions. Trust companies and stock savings banks were commercial banks for many years.

    The only tool at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be controlled is legal reserves.

    Legal reserves increased by a factor of 3.5 from 1981 until 2006. And during this same time period, the commercial banking system’s expansion coefficient doubled.

    “There is general agreement that, for almost all banks throughout the world, statutory reserve requirements are NOT BINDING. Banks need central bank deposits for clearing checks and making other interbank payments, which gives the central bank leverage over money and bond markets”

    Richard G Anderson
    Federal Reserve Bank of St Louis

    THE MONEY SUPPLY CAN NEVER BE MANAGED BY ANY ATTEMPT TO CONTROL THE COST OF CREDIT.

  • Posted by s

    One thing the people keep glossing over is how Paulson and Bernanke sat in front of Congress last year and said to everyone that they were imploring Banks to raise capital. The banks opted not to. Why? They clearly calculated that they could lie and obfuscate and in the worst case designate themselves TBTF. Thus they went on paying healthy dividends with yields in excess of 7%.

    Banks and their shareholders played chicken with the US taxpayer and they won a pyrrhic victory in the Senate. This plan is a about one thing, not diluting into oblivion JPM, BAC, C, WFC etc. And yet we see JPM hit 52 week highs. This must be what it was like on the Russian Stock Exchange in 1986.

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