classical economics
for analysis,  forecasting
and policy design

Fed Floats Funds Rate
By Wayne Jett
© December 17, 2008

    At long last, the Federal Open Market Committee effectively floated the funds rate on December 16, 2008, by declaring its new “target” to be a range of zero to 0.25 per cent. Markets already put the funds rate within the lower part of that range weeks ago, so FOMC’s action merely acknowledges reality and makes it appear intentional. Although still affected by extraordinary economic conditions, the yield curve can be “normal” for the first time in years because market influences will determine yields at all points and the low end will not be inverted.
    Recent experience adds more evidence that the funds rate “target” has been a rate set by the Fed to provide a benchmark for banks to set prime rates for bank lending. As the Fed engaged in crisis-risk management during recent months, the actual funds rate deviated widely from the target and the Fed did nothing to combat it. This was a change in practices on the part of member banks, not on the part of the Fed. Banks are provoked by extreme market conditions to depart from patterns of business as usual. With the Fed flooding the financial system with liquidity, paying one per cent for overnight funds made no sense, so the banks didn’t do it.
Wall Street Remains in Charge
    FOMC’s move is a single positive policy change in a maelstrom of awful events flowing from failed government policy. The Federal Reserve is a central element of failed policy, but so are the Treasury, the White House, Congress, the SEC and the CFTC. Each of these institutions and agencies is captive to influences of Wall Street which compromise their performances of constitutional and statutory duties.
    FOMC changed policy only after financial and economic calamity hit and threatened to worsen, and surely hopes to return to the old game plan once crisis blows past. The Fed remains blameworthy for bringing the U. S. economy to a standstill by pushing credit costs out of range for small business, while feeding liquidity to Wall Street firms which over-leveraged and binged on unsound securities derivatives. This the Fed did because Wall Street desired it.
    President Bush hired a former Goldman Sachs investment banker, Joshua Bolten, as White House chief of staff in 2006. Bolten promptly recruited Goldman Sachs CEO Henry M. Paulson, Jr., as secretary of the Treasury. The White House did this because Wall Street (and its congressional allies) desired it.
    At Goldman, Paulson lobbied for legislation in 2000 permitting a “dark market” in crude oil futures trading, exploited that market big time by creating Intercontinental Exchange, and he securitized, marketed and sold short residential mortgage-backed securities. Whether Goldman tactically sold short and failed to deliver securities to buyers is presently undisclosed, because the SEC allows such practices by investment banks and hedge funds to be termed “trade secrets.”
    With the White House and Treasury heavily influenced by Wall Street, and greater political contributions from Wall Street flowing to Democrats than Republicans, Senate and House leadership gives close attention to Wall Street desires. Consequently, the Commodities Futures Trading Commission did nothing to detect or inhibit flagrant manipulation of the price of crude oil in futures trading. The price of crude oil more than trebled in two years, causing collapse of economic growth around the world. CFTC looked the other way because Wall Street (and Treasury, and Congress, and the White House) desired it.
    Likewise, the Securities & Exchange Commission is completely compromised by Wall Street influences upon Treasury, the White House, Congress and its own staff and commissioners. Debilitated by Wall Street influences at odds with interests of ordinary investors, the agency ignores its statutory duties and criminal prohibitions within its aegis are flaunted. U. S. financial markets are as lawless as they were 80 years ago, and financial predators are armed with technology making them far more dangerous.
    After 1929, American investors suffered six more years of financial fraud before the SEC began staffing in 1935. Seventy-odd years later, the SEC buffers Wall Street players from criminal prosecution and, like the CFTC, can’t detect financial manipulation with a microscope.
Blind Man’s Bluff
    The SEC learned of Bernard Madoff’s alleged $50 billion fraud from the FBI, after Madoff’s firm disclosed it. The public’s chances of being told by the SEC of fraud at any other major Wall Street firm is essentially nil. The SEC sees its job as maintaining public confidence in U. S. financial markets, which it sees as inconsistent with finding fraud of any great consequence. That attitude has permitted fraud of gargantuan proportions.
    Don’t believe the “Ponzi scheme” story on Madoff. Almost certainly, the fraud victimized other market participants, not only Madoff’s own investors. The SEC tacitly licenses market makers and traders of large Wall Street firms to defraud investors of billions daily, and that license, unlike a Ponzi scheme, does not blow up in the face of the perpetrator over time.
Prospects for 2009
    Perhaps Wall Street desires another Great Depression. If so, the nation has tough sledding ahead. The new White House, the new Congress, the secretary-designate at Treasury, all seem dedicated to serving Wall Street’s desires at least as fervently as those currently in office. If that valuation holds, the SEC and CFTC will remain feckless.     
    FOMC alone cannot pull the economy out of the ditch it’s been driven into, even if it really tries, without teamwork from the other five institutions. Its action December 16 provides a glimmer of hope that perhaps Wall Street desires recovery. ~