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Fed Bailout of Wall Street: Not Fair to the Commercial Banks

great topic

Milton Friedman Would Have Welcomed the Fed's Intervention in Bear Stearns

Re: Deposit/currency ratio. I made a mistake. What I was thinking about was the growth of currency, which has been up since the 1920s.

Milton Friedman Would Have Welcomed the Fed's Intervention in Bear Stearns

Friedman's legacy: He graduated Ph.D. from Columbia. He was at Chicago in 32 but ran out of money. I think Wikipedia got it wrong.

Milton Friedman Would Have Welcomed the Fed's Intervention in Bear Stearns

Brad Delong you are absolutely correct. Milton Friedman would have rescued Bear Sterns. But Friedman authored only a superficial explanation, and an incomplete proposal, for preventing the Great Depression. The Federal Reserve was not yet set up to help.

Milton Friedman was not a monetarist. In fact his knowledge of money & central banking was cursory. And Milton was loath to grant central bankers much discretion in formulating and executing monetary policy.

“Friedman's calls, at times, for extremely strict banking regulation: 100% reserve banking,” in fact. Did Friedman really say that? I find that statement unbelievable. That of course would turn the member depository institutions into financial intermediaries, intermediaries between savers and borrowers. I.e., like investments banks, which are financial intermediaries.

In contrast, MCBs are money and credit creators. I.e., every time a member commercial bank makes a loan to or buys securities from the non-bank public it creates new money.

And those graphs, Milton Friedman didn’t know what our means-of-payment money was.

And the “deposit-currency ratio”. You’d better double back and check your stats. …well you’ll find out.

BSC Bailout: Fed Prevented a Domino Effect

We will eventuall operate within a command economy and into an increasingly totalitarian mold.

Fourteen Notes on Monetary Policy

"monetary base stays in the mud with barely 2% growth". The guru's, (i.e., Friedman, Greenspan, etc.), were responsible for this mess. So why follow their obvious errors? Maybe people don't need as much cash because ATM networks have reduced the "cash drain" factor (the non-bank public's holdings of currency).

Any institution whose liabilities can be transferred on demand, without notice, and without income penalty, by data networks, checks, or similar types of negotiable credit instruments, and whose deposits are regarded by the public as money, can create new money, provided that the institution is not encountering a negative cash flow.

Required reserves are: (1) member banks (applied vault cash or IBDDs maintained in their Federal Reserve Districk Banks) and (2) non-member banks (same as member banks, plus indirect pass-thru correspondent relationships).

"Reserve requirements are imposed on commercial banks, savings banks, savings and loan associations, credit unions, U.S. branches and agencies of foreign banks, Edge corporations, and agreement corporations." (Federal Reserve Board)

But reserve requirments are no longer binding - www.newyorkfed.org/res...

And the "free gratis" legal reserves non-member banks hold in member correspondent banks provide no constraint on non-member bank money creating activities. The amount of deposits these respondent banks keep in their member correspondents for bank debits & credits (clearing and other services), is much greater than the amount needed to meet their required reserves.

The previous liftoff from the dot.com recession, was driven by the expansion of "free gratis" legal reserves. In contrast, the loan-deposit growth indicated by bank credit this year, shows no such relationship.

What's happened is that the FOMC's FFR reductions have increased the demand for "loan-funds", as the profit spreads (slope of the yield curve) have increased, or borrowing costs have been reduced.

Therein lies the problem. The technicians in charge of the hour-to-hour administration of open market operations believe that there is, at any given time, a federal funds rate that is consonant with a proper rate of change in the money supply.

However, the effect of tying open market policy to a fed Funds bracket is to supply additional (and excessive legal reserves) to the banking system when loan demand increases (M3 & total bank liabilities are valid references). But at some point M3 will approximate our means-of-payment money.

See, since 1942, money creation is a system process. No bank, or minority group of banks (from an asset standpoint), can expand credit (create money), significantly faster than the majority banks expand. I.e, eventually, our primary money supply will expand until it will approximate M3.

History shows that the effect of Fed operations on repo or FFs' interest rates is indirect, and varies widely over time, and in magnitude.

The Federal Open Market Committee (FMOC) can only control the money supply through legal reserve management— this is the only method available in a free capitalistic society.

The first rule of reserves and reserve ratios is to require that ALL money creating institutions have the SAME legal reserve requirements, both as to types of ASSETS ELIGIBLE for reserves, as well as the LEVEL of reserve ratios.

Monetary policy should limit all reserves to balances in the Federal Reserve banks (IBDDs, the original definition in 1917), and have UNIFORM reserve ratios, for ALL deposits, in ALL banks, irrespective of size.

But this is a pipe dream, because PAC money is the driving influence. So we can expect more of the same (a boom-bust economy) -- only worse.

The Fed Defends the Indefensible

Long ago (early 60's, Citibank pioneered the Negotiable CD). Prior to this, the member commercial banks operated by "storing" their liqudity. But when the E-Dollar rates came to exceed the Reg Q ceilings, funds were pulled out of some large New York City banks (they landed in foreign money markets).

The Fed caved in order to rescue these banks (they raised Reg Q ceilings). Obviously you cannot buy your liquidity if you can't pay market rates of interest. And so it went.

Things have evolved and as our legislators have caved in, and continue to cave in, (to the demands of the powerful banking lobby), member commercial banks are now permitted to "buy" their liquidity (with instruments sporting progressively higher risks).

And it seems certain that at some point, we will not be able to recover from this greed, and the associated self-serving deregulation, all of which is sponsored by special interest groups.

Ten Notes on the Financial System and Our Quasi-Government

Poole was a conservative at the "Maverick" Federal Reserve Bank of St. Louis. But I am disturbed with people who spend their entire careers at something, & never end up grasping how things work: Dr. William Poole: "The depreciation of the dollar is something that is not explicable. And the way I like to phrase this – I like to put my academic hat back on. If you look at academic studies of forecasts of the exchange rates across the major currencies, you find that the forecasts are simply not worth a damn."

If the world's largest economy ($14b+) has a contraction in its gdp, imports will fall, & export driven countries will suffer, exacerbating the negative (reversal) in the flow of funds, and any currency crisis. Forecasting results (some using 1 & some using 2 different time series:

Mexico crisis 2/17/1982 (not identified) - Peso was pegged

Listed below, currency crisis that were predictable & preventable

(1) Black Monday Oct 19 1987 (same day)

(2) Mexico Peso crisis Dec 1994 (2 months early) Peso was pegged

(3) U.S. dollar fall in Mar. 1995 (same month)

(4) Asian financial crisis July 1997 (one month late)

(5) Russian financial crisis 1998 (same month)

Poole made some brash statements he couldn't defend.

Ten Notes on the Financial System and Our Quasi-Government

Re - the red tide: Hope for repayment?

Between 1933 and 1935, the RFC purchased more than $1 billion in preferred stock in individual banks. To gauge the significant size of this agency's activity, in 1935 the total book value of equity capital (including the RFC investment) for all commercial banks was $3.6 billion. New RFC bank investment effectively ended by late 1935, and banks gradually repurchased the government's stock out of their earnings when the banks subsequently returned to profitability.

In the Wake of Bear: I-Bank Regulation Now in Fed's Hands

Very much enjoyed your viewpoints.