Bill Black, an expert on banking and white-collar crime, described how Donald Trump’s appointees to the Federal Reserve Board are revising “stress tests” to free Goldman Sachs and Morgan Stanley from a requirement to prove they are solvent enough to weather the next recession.
To pass the “stress test,” they’d have to put a larger fraction of their profits into capital reserves. Black said they could easily do this, but it would cut into bonuses and dividends.
He also noted that Germany’s Deutsche Bank in Germany can’t even pass the easier stress test. Deutsche Bank is Germany’s largest bank and, according to Black, the only large bank willing to lend to Donald Trump’s businesses.
Ever since the 2008 crash, the Federal Reserve Board has had the U.S. financial markets on life support.
The Fed has used its influence on the banking system and bond market to drive interest rates down to near zero. Taking inflation into account, many interest rates are less than zero.
This drives investors who want a return on their investment into the stock market, and the fact that we’re in the market helps keep prices up. But the rise in stock prices is not based on profitability of underlying businesses.
The idea is that low interest rates and a rising stock market will encourage new investment and a growth in the real economy. But when the Fed hints that it may allow interest rates to return to normal levels, investors panic and the market falls.
Another way the Fed has tried to stimulate the economy is by “qualitative easing”—buying up banks’ so-called toxic investments. This is supposed to empower the bankers to find better investments, which would enable the economy to grow. But this was never a requirement.
Right now wages are rising and unemployment is falling. It would be great if this continued for a long period of time.
Artificially low interest rates cannot go on forever and, as Stein’s Law says, if something cannot go on forever, someday it will stop.
The Federal Reserve Board’s policy of qualitative easing has helped the stock market recover. But Americans who work in the real economy are still struggling.
Qualitative easing is the Federal Reserve Board’s policy of creating new money to buy Treasury bonds in order to keep interest rates low. The greater the demand for bonds, the lower the interest rates, and the interest rate on Treasury bonds is generally the benchmark on all Treasury bonds.
The Fed’s Operation Twist was a sale of medium-term Treasury bonds and purchase of 10-year bonds. The Federal Funds rate is the interest rate for overnight loans among banks so they can meet the Federal Reserve’s requirement for reserves.
The chart above shows how QE correlated with the ups and downs of the stock market. But, as I indicated in a previous post, American corporations did not advantage of low interest rates to invest in their businesses. Instead they have transferred the gains to stockholders in the form of stock buybacks.
An economic recovery has taken place. Most Americans are better off than they were at the depths of the crash. But as economic recoveries go, this one has been weak.
The chart shows how important is it to always adjust for inflation. A dollar in the year 2000 is not the same thing as a dollar in the year 2016.
Although corporate executives did not take advantage of Qualitative Easing to invest in America, there was nothing besides politics holding back the federal government from investing in public works. There is a lot of urgent work that needs to be done in maintaining and upgrading American’s physical infrastructure, such as upgrading public water systems to get the lead out.
With a lot of public work that needs to be done, a lot of people who need work and financing costs at historic lows, why not put the unemployed and under-employed to work doing what needs to be done? Fiddling with interest rates and the money supply is not enough.
The Open Market Committee of the Federal Reserve System has raised a key interest rate from a quarter of a percentage point to half a percentage point.
Many economists and writers fear this may sink the economic recovery. I say that if such a minute change will sink the recovery, the recovery was leaky to begin with.
The interest rate is the Fed Funds target rate, the interest rate at which banks lend money to each other overnight in order to have the minimum reserve funds required by the Federal Reserve System.
One of the goals of the Federal Reserve System is to strike a balance between unemployment and inflation by regulating interest rates and the supply of money.
The idea is that when interest rates are low, people borrow more money to spend and investment, resulting in more jobs but also inflation and price increases. When interest rates are high, the reverse supposedly happens.
But key interest rates have been at nearly zero (or below zero according to some measures), and the economy hasn’t responded. The increase in jobs is much less than in previous economic recoveries, while inflation continues low.
The Federal Reserve Board is reportedly thinking about negative interest rates as a means of stimulating the economy.
“Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” said William Dudley, the president of the New York Fed, in an interview on CNBC on Friday.
Negative interest rates are just what they sound like. Depositors would pay banks to keep their money rather than being paid interest. This is crazy. Why would the Federal Reserve Board members even consider such a thing?
The idea is that if our economic problem is too much saving and too little spending, you can stimulate spending by penalizing saving.
The idea is that if low interest rates stimulate spending and investment, which produce economic growth, then negative interest rates would be an even better stimulus.
The negative interest rates would apply to funds that individual banks, such as M&T Bank here in upstate New York, deposit with a central bank, such as the Federal Reserve Bank of New York.
The negative rate wouldn’t necessarily apply to individual depositors, although it might. Central banks in Germany, Switzerland, Denmark and Sweden have imposed negative interest rates, and individual banks have charged depositors for holding their money.
The Federal Reserve Board will soon decide once again whether to continue to hold down interest rates or to allow them to rise.
The board is in more or less the same position as a physician trying to decide whether to remove life support a patient who is in intensive care.
All the indicators are that the patient is too weak to be removed from life support. Yet the patient can’t stay on life support forever.
I used to criticize the Federal Reserve Board on the grounds that it preferred tight money and high unemployment to the possibility of inflation. That’s yesterday’s news. Now the Fed’s concern is how to get the country out of its long-term recession.
The historic Keynesian remedy for recession is to increase the money supply and hold down interest rates. The idea is that putting money in circulation and making credit readily available will encourage consumers to buy things and businesses to invest.
But this time around, it didn’t happen. Banks and financial institutions invested in debt rather than in production of tangible goods and services. Savers invested in stocks and bonds because they couldn’t get any interest on their bank accounts, but this didn’t stimulate the real economy either, or at least not very much.
It’s interesting that the report of gains in jobs and a drop in unemployment was followed by a drop in stock prices.
Conceivably this could be been due to the improvement being less than expected, but analysts quoted in my morning newspaper said investors fear that the apparent recovery will cause the Federal Reserve Board to stop holding down interest rates in order to stimulate the economy.
A certain number of people can be expected take their money out of the stock market and put it in savings accounts in banks, or in bonds, because they would getting actual interest income again.
In other words, stock prices reflect an unsustainable government policy, and not the real health of the economy.
Richard Fisher, president of the Federal Reserve Bank of Dallas, said it may be necessary to raise interest rates if the unemployment rate falls below 6.1 percent because low unemployment could lead to higher wages.
Fisher pointed out that in Texas, wages are rising faster than the rate of inflation.
To me, that is a good thing, not a bad thing. Why interfere with the law of supply and demand? The only reason that I can think of is that it might decrease the market value of financial assets.
I am reminded of Karl Marx’s claim that “a reserve army of the unemployed” is necessary to the functioning of capitalism.
I believe in the value of self-discipline, education and the willingness to work. But anybody who preaches these values ought to be able to show that there is a payoff, and that the payoff is available to everyone, not just the exceptionally talented and the exceptionally lucky.
If the economic system is set up so that at least 6.1 percent of the work force is unemployed at all times, then there is no way to rise out of that 6.1 percent without knocking somebody else down into it.
Right now the stock market is like Wile E Coyote in the Road Runner cartoons. He can run for a while with nothing supporting him—just so long as he doesn’t look down and realizing he is standing on thin air.
Holders of financial assets have enjoyed a good economic recovery. But what is holding it up is the Federal Reserve System’s policy of keeping interest rates as close to zero as possible. If savers and investors can’t earn interest on their bank savings accounts or money market funds, and very little in the Treasury bond market, they have no choice but to venture into the stock market if they want income.
The hope of Ben Bernanke and the governors of the Federal Reserve Board is that the recovery will become self-sustaining, but each time they talk about or start tapering off, the stock market drops. This hope has not been realized. Without a recovery in the real economy, the employment of people to produce goods and services, stock price averages are bound to fall back.
We like to say that the U.S. government is financed by borrowing from China. That’s either a metaphor or an exaggeration. Most of the U.S. government debt is owed to Americans and much of it to government trust funds, but it is true that if Chinese and other foreign investors decided U.S. Treasury bonds were a bad investment, financing the U.S. government would become a lot harder.
Since the Federal Reserve Board holds $2.1 trillion worth of Treasury bonds, Florida Democratic Rep. Alan Grayson argued that the debt crisis could be postponed if the Fed simply forgave this debt or suspended collecting interest payments. Click on Bernanke Could End the Debt Limit Crisis for Grayson’s argument.
I think this would work. I think it would set a bad precedent. I think it might be worth risking the bad precedent, but I’m pretty sure that the Federal Reserve Board thinks differently.
Elizabeth Drew reported on how the Republican victory in state legislature elections in 2010 enabled them to redraw legislative and congressional districts so that they can win a majority of seats even without a majority of votes. Republicans have a majority of votes in the House of Representatives, and the Tea Party bloc has a majority in the Republican caucus. So a political minority is in a position to veto what a majority of voters want.
I don’t admire the current Democratic leadership, with a few exceptions. I think the current Republican leadership is worse, also with a few exceptions. Even if Americans only have a choice of evils, they deserve a free and fair choice.
The United States has a disgraceful history, going back to the Vietnam Conflict, of abandoning foreigners who served the U.S. military in our unsuccessful wars. We seem to be about to repeat that history in Afghanistan. Whatever the rights and wrongs of U.S. policy in Afghanistan, we Americans have a moral obligation to our troops who risked and sacrificed to carry out that policy, but to their Afghan comrades who put their trust in the United States.
The Malayan Communist guerrilla leader Chin Peng fought the British, the Japanese and the newly independent government of Malaya, and spent the last third of his life in Thailand, where he died last month at the age of 88. More than 30 years after he laid down his arms, the Malaysian government forbids his body to be returned to his home country for burial.
I got virtually no interest on my bank account or my money market fund, so if I don’t want the real value of my retirement savings to dwindle because of inflation, I need to keep a portion of them in stock and bond mutual funds. The reason that interest rates are close to nothing is the Federal Reserve Board’s policy.
Larry Summers and Janet Yellen are considered to be the two most likely choices for President Obama to nominate as chair of the Federal Reserve Board. It’s a sign of the times that the fact that Yellen is prudent and sensible is enough to define her as the candidate of the liberal left.
Michael Hudson, a research professor of economics at the University of Missouri at Kansas City, said the Federal Reserve Board’s Qualitative Easing is a continuation of the bank bailout under another name.
Ben Bernanke, chair of the Federal Reserve, announced a commitment to buy mortgage-backed securities (toxic assets?) while keeping interest rates low. Pumping more money into the economy will supposedly make more money available for business loans and consumer purchases in the United States. But Hudson noted that so far the banks have found more profitable things to do with the Fed’s money than to invest it in the real U.S. economy.
At present the rate of inflation is low. But one cause (or definition) of inflation is too much money chasing too few goods. If money is created, but the money is not used to produce more goods, then (as I see it) inflation could return. Moderate inflation is supposed to be a cure for economic stagnation, but I can recall the “stagflation” of the 1970s when there was very serious inflation and economic stagnation at the same time.
The prevailing wisdom in Washington and on Wall Street is that creating jobs, rebuilding the nation’s infrastructure and even maintaining basic government services is unaffordable. Yet the Federal Reserve System was able to come up with $1.2 trillion to bail out failing banks and financial institutions.
This information was kept secret until Bloomberg Business News pried it loose a few days ago. To get the information, Bloomberg needed the Freedom of Information Act, lawsuits that went to the Supreme Court and an act of Congress.
The size of the bailout boggles the mind.
Fed Chairman Ben S. Bernanke’s unprecedented effort to keep the economy from plunging into depression included lending banks and other companies as much as $1.2 trillion of public money, about the same amount U.S. homeowners currently owe on 6.5 million delinquent and foreclosed mortgages. … …
The $1.2 trillion peak on Dec. 5, 2008 — the combined outstanding balance under the seven programs tallied by Bloomberg — was almost three times the size of the U.S. federal budget deficit that year and more than the total earnings of all federally insured banks in the U.S. for the decade through 2010, according to data compiled by Bloomberg.
The balance was more than 25 times the Fed’s pre-crisis lending peak of $46 billion on Sept. 12, 2001, the day after terrorists attacked the World Trade Center in New York and the Pentagon. Denominated in $1 bills, the $1.2 trillion would fill 539 Olympic-size swimming pools.
The Federal Reserve Board’s justification for the bailout, according to Bloomberg, is that the bailout was necessary to prevent the collapse of the financial system, that the loans were (mostly but not always) at above-market interest rates, that they were (mostly but not always) backed by adequate collateral, and that the loans were paid back.
I agree it was necessary for the Fed to act to prevent the banking and financial industry from collapsing. There would have been a domino effect that would have spread through the whole economy, as in the bank failures of earlier eras. But the rescue should have been like the rescue of General Motors and Chrysler.
In the auto industry rescue, government help was conditioned on getting rid of the incompetent managers who’d caused the problem, letting the stockholders and bondholders take a loss and restructuring the companies so they will be on a sounder footing in the future.
In contrast, the bank bailouts protected the jobs and bonuses of top management, shielded stockholders from loss and allowed a continuation of everything that led to the problem in the first place.
I grew up in the 1940s and came of age in the 1950s. My economic behavior and attitudes were shaped by my parents’ memories of the Great Depression of the 1930s.
My guess is that the behavior and attitudes of most Americans younger than 50s is the Great Inflation of the 1970s, when the Consumer Price Index rose more than 10 percent almost every year, peaking out at 15 percent in 1980.
Inflation turned all the rules of rational behavior upside down. People who saved their money saw the value of their savings dwindle down to nearly nothing (the stock market was virtually flat during that decade) while those who borrowed money and spent it were the prudent ones.
Paul Volcker
President Nixon stopped inflation temporarily by imposing wage and price controls, but this did not get at the root of the problem. President Gerald Ford tried an ineffective voluntary program called WIN – Whip Inflation Now. President Jimmy Carter appointed Paul Volcker at chair of the Federal Reserve Board, and Volcker acted to stop inflation in the only way he knew how – by choking off the growth of the U.S. money supply. Volcker’s action choked off the availability of credit. Many small businesses, which depend on credit, went broke.
A recession began in which unemployment went into double digits. President Carter supported Volcker. He did not try to reverse the Federal Reserve’s policies, nor did he distance himself, even though this cost him whatever chance he may have had to be re-elected. President Reagan did the same, even though the recession put his re-election at risk.
On this question both Carter and Reagan were patriots who did what they thought was necessary for the public good even when it was to their political disadvantage.
The recession came to an end, and the CPI has been low ever since. This was a good achievement, but as in other Reagan administration policies, it generated bad memes. One meme is that you can act in the interests of bankers against workers and small-business owners and not pay a political price. Another is that fighting inflation, even when inflation is as low as it is now, is the overriding goal to which economic growth, employment and everything else must be subordinated. Legislation is now pending before the House of Representatives to change the charter of the Federal Reserve from the dual mission of promoting low inflation and economic growth to low inflation only.
Click on Stagflation wiki for the Wikipedia article on 1970s inflation and how economists explain it.Click on The Inflation of the 1970s for a 1995 presentation by Brad DeLong, an economist of the faculty of the University of California at Berkeley. DeLong thought one possible cause of the Great Inflation was simply that decision-makers were slow to give priority to inflation-fighting. Another was the failure of the Johnson and Nixon administrations to raise taxes to pay for the Vietnam war. A third explanation is the oil price shocks of 1973 and 1979 combined with similar less-publicized price shocks for other commodities.Political writer Kevin P. Phillips pointed out in 2008 that the formula for calculating the Consumer Price Index was changed under the administrations of Presidents Kennedy, Johnson, Nixon, Reagan, George H.W. Bush and Clinton. All the changes made the rate of inflation seem lower. This diminishes Reagan's achievement, but he was no worse than many of his predecessors and successors, and nobody who remembers that era doubts the important victory over inflation.Click on Numbers racket for Phillips' 2008 article in Harpers about manipulation of economic statistics.
The above charts on changing methods of calculating inflation are based on information from a consulting economist named John Willliams. Click on Shadow Government Statistics for his web site.
Click on The Reagan Years for a menu of links to statistical information compiled by Steve Kangas on the Reagan era’s economic policies. [Added 2/25/11]
Last night I saw an Charles Ferguson’s “Inside Job,” a documentary movie on the Wall Street crisis. It is excellent journalism and excellent cinema. Most people who see this movie will leave it not just angry, but better-informed. Ferguson both names the culprits behind the crisis, and clearly explains the deeper systemic problems.
Ferguson makes the point that there has been no criminal prosecution of financial manipulators, unlike in the lesser savings and loan crisis of an earlier era. Maybe there is not only such a thing as “too big to fail,” but “too powerful to prosecute.” The Charles Keatings of that era had much less clout than the Henry Paulsons of today.
Ferguson does not go easy on the Bush administration, but he shows origins of Wall Street’s capture of the government in the Reagan and Clinton administrations and its continuation in the Obama administration which, as in so much else, continues the Bush policies with many of the Bush appointees.
He shows the conflicts of interest among top economists, who receive big consulting and directors’ fees from the financial industry they supposedly are analyzing impartially. Long ago there was a scandal when radio disc jockeys accepted payola from record companies to play certain records. We ought to be equally scandalized about payola to academics. But in fact, these economists are still treated with respect by officialdom and the press, while the economists whose warnings proved true are still regarded as marginal figures.
Poul Anderson wrote a short story 26 years ago entitled “Fairy Gold” which illustrated how economic stimulus is supposed to work better than anything else I know of.
Poul Anderson
The situation was that a brave but penniless young man wanted to join a voyage of merchant adventurers, but lacked the money to buy a share of the expedition. His sweetheart wanted him to stay home and work in the pottery shop which she inherited from her grandfather. Unexpectedly, a bunch of elves maneuvered him into fighting an ogre and at sundown, as a reward for his victory, gave him a a five-pound gold coin, with the warning to spend it quickly.
The young man exchanged the enormous coin for regular money with a banker, and bought himself a share of the ship’s expedition. The banker exchanged the gold for diamonds at a profit; the jeweler bought pearls from the ship’s captain. The captain gave the gold to a beautiful aging courtesan, whom he loved, and she bought the shop from the young man’s sweetheart in order to have an income when her beauty faded. Without responsibility for the shop, the young woman saw no impediment to joining the young man on the expedition. She rushed to join him, just as the sun came up and the gold coin evaporated, because it was fairy gold. But although it wasn’t real, everyone concerned was better off for having had it.
Last week the Federal Reserve Board conjured up $600 billion out of nothing, which it will use to buy government bonds. The board hopes the $600 billion will go sloshing through the economy, and create effects similar to the fairy gold in Poul Anderson’s story.
Maybe it will. It certainly is not going to evaporate at sunrise. But it may not go circulating through the economy, either, as might have been the case in earlier recessions. All classes of people and institutions are in debt – individuals, businesses, local governments, banks. The prudent thing for them to do if a little extra money comes into their hands is to put it away. Or invest it in a foreign country, where interest rates, unlike in the United States, are higher than near-zero.
Financial legerdemain got us into the mess we’re in. I don’t think we can count on financial legerdemain to get us out.
Phil Ebersole's Blog 