classical economics
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Bernanke and the Boss

Chairman Begins Second Term on Precipice
By Wayne Jett © February 3, 2010
    After one term as chairman of the Federal Reserve, Ben Bernanke knows who is boss. The chairman of the Fed is not the boss, nor is Congress, nor the president. He learned in those 2008 meetings when Henry Paulson announced the fates of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Bros. and AIG. The Wall Street players called the shots. Bernanke funded their game.
    Campaigning for reappointment, Bernanke proudly asserted the Fed’s actions averted “Great Depression II ...” With his confirmation now safely behind him, the chairman may clear his throat and finish his statement: “… for the moment.” The Federal Reserve is more precariously positioned at present than at any time in its history. The Fed’s path back to stability is outside Bernanke’s control.
    Not long ago, say 2007, the Fed’s reputation continued to be staid financial conservatism, although its actions included manipulation of the dollar’s value. Interests of Wall Street banks were uppermost then, as now, but the Fed was loathe to risk funds for any other purpose. Its member banks had total reserves of $43.3 billion at YE 2006 and $44 billion at YE 2007. Then the events of 2008 transpired.
Banks Flee Private Lending
    Total bank reserves were $44.6 billion at the end of August, 2008, and then leapt to $821 billion at YE 2008. From there, total reserves leapt again to $1.13 trillion at YE 2009. Meanwhile, required bank reserves rose from $41.5 billion at YE 2006 to $63 billion at YE 2009. Of total bank reserves at YE 2009, $170 billion were borrowed from the Fed and $969 billion were non-borrowed capital from the banks.
    This represents an historic move by private banks to invest capital with the Federal Reserve rather than in the private economy. At YE 2009, total residual (net worth) of banks was $1.2 trillion, and essentially all of it was deposited as reserves at the Fed. Why did banks do this?  
    Financial fraud, Treasury, the Federal Reserve, FDIC, OTS and related regulators froze private investment and credit markets and shut down the U. S. economy in September, 2008. The Fed and Treasury stepped into the breach. The Fed came with newly created money. Treasury came with borrowed money, acquired at low rates as capital fled private investment, and intended to borrow much more.
    Congress gave the Fed authority to pay interest on reserves for the first time October 1, 2008. The Fed now pays private banks 25 basis points (1/4 of 1%) interest on bank-owned capital deposited as reserves. Banks pay about 13 bps as interest on borrowed capital deposited as reserves, and are paid 25 bps by the Fed, leaving a narrow profit of 12 bps. This ultra-low-or-no-margin business plan is focused on institutional survival – banking at bare bones level.
    Total assets of banks were $11.6 trillion at YE 2009, down from $12.3 trillion at YE 2008. Sharply increased bank reserves do not represent growth in bank equity capital or lending capacity. Lending into the private economy remains hazardous. Borrowers are under increased stress in the weakened economy, so risk of default is relatively high.
    The weakened economy was caused by a more fundamental reason for the banks retreat from private lending. An array of government policies drove the weakening process. In the banking sector, federal regulators continue shutting banks weekly on grounds of inadequate capital. Any bank lending into the private economy may become next Friday’s WaMu.
     Recall Washington Mutual’s shareholders discovered their bank was seized when its capital exceeded requirements by three times over. WaMu’s share price was under attack by heavy naked short selling at the time. The FDIC grabbed WaMu and gave it to J. P. Morgan Chase (after its gift of Bear Stearns), helping to make 2008 Chase’s “best year ever.”    
Why Giant Bank Reserves?
    As banks moved $1 trillion into reserves at the Fed, money creation by the Fed increased the monetary base from $824 billion at YE 2007 to $1.65 trillion at YE 2008 and to $2 trillion at YE 2009. The Fed created $1.17 trillion in new money and used it to buy financial assets from selected financial institutions, while banks across the country liquidated assets and moved $1 trillion into reserves deposited with the Fed.
    Why the near symmetry, and what are its implications? Answers are not transparent, but directions of funds flow appear consistent with patterns since about 2005 when Fed policies diverted liquidity from small business and main street towards the Wall Street financial sector.
    The Fed insists its actions in 2008-2009 were demand responses to emergent crises – not affirmative choices. Believing this requires accepting the premise that private economies collapse of their own volition without government culpability. To the contrary, government played pivotal roles in bringing about the economic debacles of 2008-2010. The Federal Reserve is a private central bank, but it works in tandem with government players because all have the same boss: the entity Britain’s Gladstone called the Money Power. ~