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September 15, I asked the question "Is the Financial System Any Safer or Sounder 5 Years Later?" The primary concern in this discussion was the "Shadow" banking system.

Now, we hear from Sheila Bair, the former chair of the Federal Deposit Insurance Corporation, the FDIC, in the Financial Times that maybe we should not take our eyes off the commercial banking system.

Ms. Bair writes: "banks are only marginally safer than they were before the 2008 crisis."

It would seem to me that if anyone should have a good feel for what shape the banking system is now in, it should be Sheila Bair. After all, she was there in 2008 and she has sufficient current knowledge of the state of the banking system to be able to make such a statement.

This revelation, to me, is similar to one made by Elizabeth Warren in front of Congress when she was the Special Advisor for the Consumer Financial Protection Bureau. Ms. Warren, at the time, indicated to Congress that whereas there were over 600 commercial banks on the list of problem banks compiled by the FDIC that there was maybe two to three times that number of banks that were in serious trouble.

At that time, in the 2011 time period, there were a little less that 6,500 banks in the commercial banking system. This was an eye-opener!

Furthermore, this information is tied in the article to the prospect that the Federal Reserve will begin to "taper" its monthly purchases of securities.

Although she doesn't mention it in her article, this raises another question to me about the rationale behind all three efforts of the Federal Reserve to achieve quantitative easing.

The Federal Reserve has couched its discussions about quantitative easing in terms of the state of the United States economy and the high level of unemployment that exists in the country. Slow growth and high unemployment rates need to be overcome and quantitative easing, we were told, are the answer.

However, I have been raising a question since QE1 about the real reason behind this policy approach at the Federal Reserve. Since the quantitative easing did not seem to be doing too much to the economy, I wondered if the fundamental reason for QE1 and beyond was the safety and soundness of the banks.

So many of the commercial banks were still is such a distressed state that the Federal Reserve was injecting all of this liquidity into the banks so that those having the greatest difficulty could be closed in the smoothest and most efficient way by the FDIC.

The interesting thing about this injection is that the commercial banks, for the most part, held onto the bank reserves being created and did not loan them out.

And this behavior continues to this day. The funds injected into the banking system still rest on the balance sheets of commercial banks as "cash balances." On the Fed's balance sheet, they are included in the account "Reserve Balances with Federal Reserve Banks." These reserve balances totaled $2.3 trillion on September 11, 2013. (For more on this one can check out my recent post on the subject.)

The banks haven't been lending these reserves. Yes, the economy is not strong, but maybe, I suggested, just maybe, a lot of commercial banks don't want to lend because they don't want to risk having any more bad assets on their books.

The quantitative easing on the part of the Federal Reserve gave the banks … and the FDIC … to work things out.

Now, although there are less than 600 commercial banks on the FDIC's list of problem banks, the banking system is still shrinking at the rate of around 200 banks per year, primarily through mergers and not through specific bank closures. And, even if there are at least the same number of banks that are distressed, similar to the picture presented by Ms. Warren, this would still indicate that maybe, just maybe, "banks are only marginally safer than they were before the 2008 crisis."

Thus, the concern, on the part of Ms. Bair about the possibility that the Federal Reserve will begin to "taper" its monthly purchases of securities.

Ms. Bair writes about "an eventual return to normalized interest rates." While this "return" will be good for "savers, as well as markets, which have been distorted by the Fed's intrusions," she continues, "no path to normalization could be challenging, particularly for U.S. megabanks."

That is, rising interest rates could do real damage to the banking system.

And, she concludes that "foundations are hard to build amid storms threatened by tapering. Millions of families that suffered in the Great Recession are only clawing their way back. For their sake, let us hope the Fed can gradually end this era of cheap money without significant market upheaval."

Ms. Bair was heading up the FDIC at the time the Federal Reserve introduced and was conducting quantitative easing. Ms. Bair was a part of the rescue effort to smoothly and effectively get rid of the insolvent banks during the crisis.

She, now, is very concerned that the ending of quantitative easing will not cause "significant market upheaval."

It seems to me that she is confirming the fact that the policy of quantitative easing has been as much about saving the banking system as it has been about reducing unemployment. She is now afraid that the end of this effort that she was a part of will cause the very thing that she fought so hard to prevent.

Source: 'Banks Only Marginally Safer Than Before 2008 Crisis'