Later this afternoon Helicopter Ben will come close to admitting that Quantitative Easing was a complete bust. The Fed’s balance sheet has bloated to $2.7 trillion dollars (as big as the biggest “Systemically Dangerous Institutions” it is supposed to regulate). (http://www.huffingtonpost.com/2011/04/26/federal-reserve-qe2-bernanke_n_853685.html) Remember that every dollar of assets the Fed holds means a dollar of Fed liabilities—largely notes and bank reserves, what are called “high powered money”. And what did we get for all the Fed’s largesse? Mostly, ZIP. The idea was that the unprecedented Fed intervention would reboot bank lending. Yet three years later, total bank loans are lower than they were before the Fed undertook Quantitative Easing.
In the first phase, known as QE 1, the Fed bought $1.75 trillion dollars worth of assets from the banking system in order to reduce long term interest rates. According to the NYFed, this lowered long term rates by an estimated 50 basis points. (http://www.levyinstitute.org/pubs/wp_645.pdf) That is one-half of one percentage points. The stated purpose was to encourage bank to make low cost loans to borrowers. Think about that, folks. Almost 2 trillion dollars spent to lower your borrowing cost from, say, 7.5% to 7%. Given the choice, I’d rather have the trillions.
To make matter worse, the banks did not actually make loans. No matter, as you did not want to borrow even at the lower rate. You are already buried under debt and banks have loads of bad loans. Instead, the banks just held reserve deposits at the Fed and earned 25 basis points. Meanwhile, you lost your job and your spouse took a cut in pay and hours, you lost your house to foreclosure, and the Fed fiddled around with Banksters.
Uncle Ben then ramped things up with QE 2, which planned to dump another $600 billion of excess reserves into banks by purchasing treasuries. According to the NYFed’s own staff report, that should have lowered long term rates by another 18 basis points—0.18 percentage points. That loan you did not take out could have fallen from 7% to 6.82%. Oh Joy! Again, wouldn’t you rather have the $600 billion?
Financial institutions are borrowing directly from the Fed at near zero rates to trade in existing assets—many of which they sell-on to the Fed. How about having the Fed give you some of that free money? At zero interest loans from the Fed, an awful lot of people would be able to pay off high rate mortgages and keep their homes for the $2.35 Trillion the Fed wasted in Quantitative Easing.
And here is the bigger point. The result of all this QE pumping of reserves simply removed assets from bank balance sheets that were earning them, say, 3% or more and substituted assets that earn 0.25%. Not only did QE have no benefits for borrowers, it also reduced bank earnings. True, in the initial phase of QE, the Fed bought a wide range of assets from banks—including some of those trashy subprime securitized products that created the global financial crisis in the first place. I presume the banks were rather happy to unload that garbage onto taxpayers.
But Fed purchases of Treasuries simply took the safest earning assets off bank balance sheets and gave them exceedingly low interest rate deposits at the Fed. It would be as if your bank offered to replace your FDIC insured savings deposits with lower interest FDIC insured checking deposits. Would that “QE” make you more likely to run out and spend? Nope. Uncle Ben thought it would encourage banks to go hog-wild, rebooting their NINJA lending to half-crazed home flippers. Nay, not even the speculators are that delusional. What was that Bushism? “There’s an old saying in Tennessee — I know it’s in Texas, probably in Tennessee — that says, fool me once, shame on — shame on you. Fool me — you can’t get fooled again.”
QE was a slogan, based on a rather bizarre interpretation of Japan’s two-decades-long depression. Uncle Ben’s conceit was that Japan waited too long to lower rates to zero through the use of QE. Hence, the Fed would move more quickly and then the policy that failed miserably in Japan would work in the US. It didn’t. Yes, we implemented ZIRP (zero interest rate policy) more quickly, but it had the same result here—ZIP.
So what’s a Fed to do? Return to “watchful waiting” as the Fed’s FOMC put it in December 1996. That term was used nearly three decades earlier, in 1968 when the Fed was concerned about what it perceived to be potentially excessive fiscal stimulus that might cause inflation. http://research.stlouisfed.org/publications/review/69/05/Federal_May1969.pdf
This time around, the problem is commodities price inflation that is feeding through to other prices. The goldbugs are having a field day. They claim that the Fed’s QE has driven gold prices up because of all those reserves held by banks, which fuel inflation fears and a run to gold and other “inflation hedges”.
In truth, ZIRP combined with still-collapsing real estate prices have left precious few options for money managers who must earn returns that beat the market average. Commodities and equities are the only games in town. At least, they are the only legal games in town—the biggest banks just cook their books and run Madoff-type pyramid schemes. Like subprimes in 2006, everyone knows the whole speculative superstructure as well as the big bank frauds will collapse. Meanwhile, good returns and even better bonuses are recorded.
And, again, the Fed turns a blind eye to the bubbles—since, as it has always argued, it is impossible to recognise a bubble until it bursts and you have to peel the sticky bubblegum off your face.
So, yes, it really is the Fed’s fault, but those excess reserves that were created by QE 1 and QE 2 are just Hitchcock’s MacGuffin. (http://en.wikipedia.org/wiki/MacGuffin) Banks cannot do anything with them. They do not encourage lending. They cannot cause inflation. If anything, they just reduce bank profits.
The real scandal is that the Fed refuses to own up to its impotence when it comes to managing the macro economy through reserves and overnight interest rates. Where the Fed really could have power—regulating, supervising, constraining, and even shutting down systemically dangerous financial institutions—it refuses to act. As such, we are heading full speed toward another financial collapse.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Tuesday. He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).
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