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Bernanke’s Exit Plan: Another Giveaway To Bankers at Trader’s Narrative

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bernanke amusedBernanke outlined today the Fed’s exit strategy. You can read Bernanke’s prepared remarks here at the Federal Reserve website. While he mentioned a handful of tools at the disposal of the Fed, Bernanke was careful to outline a plan in broad strokes rather than specifics. And he also left out any mention of timing because of the obvious fragile nature of the US economy.

Unfortunately, he’s painted into a corner. The avalanche of liquidity that the Fed pumped into the market throws an ominous shadow of inflation or hyperinflation. Personally, I doubt that is going to happen any time soon because even now, deflationary forces are still winning in the US economy. Nevertheless, the worry is that eventually, things will shift from deflation to inflation as the recession ends and we return to a growing economy. So the Fed has to telegraph to the market it is intelligent enough to foresee this and be prepared with a plan. This is basically what Bernanke was trying to do.

Among the tools at the disposal of the Fed is the ability to pay interest on excess reserves in the banking system. Central banks around the world are divided on this and until recently the US did not pay any interest on excess reserves. But since October 2008 it has done so and Bernanke floated the possibility of not only continuing to do so but to increase the rate to remove liquidity from the economy. We’ve already looked at how incredibly skewed things have gotten since this incentive was introduced - Excess Reserves: Bankers Grow Fat While Public Starves.

While this is theoretically sound, the result will be to increase even more the reward for banks to not actually engage in banking activity (that is, lending). Right now, this is would be disastrous because of the dramatic shift in excess reserves which are approaching $1 trillion US dollars. And the complete lack of lending which is choking business activity (see chart in above link).

We’ve been witness to the largest theft from the public to the wealthy oligarchs in history. The US has been for some time now shifting wealth from the majority to a very very tiny minority - just take a look at its Gini coefficient over time. But this is just astounding. In one fell swoop trillions of dollars have changed hands from the public, via a government that is captured by corporate interests and a Federal Reserve who is more a cheerleader than a regulator, to the banking elite.

Maybe I’m wrong about Bernanke. I hope that I am. But his pattern of decisions, from his tenure as a yes-man to Greenspan through to the TARP mess, leaves me with very little hope.

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2 Responses to “Bernanke’s Exit Plan: Another Giveaway To Bankers”  

  1. 1 DaveInDenver

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    I disagree that paying interest on excess reserves “starves” the lending market for funds. In fact, in this commentary, I argue that paying interest on excess reserves is ultimately mostly useless as a policy tool:

    His next tool would be to raise the interest rate being paid on bank excess reserves. The idea would be that banks will be incentivized to keep those reserves with the Fed rather than use them to fund lending. The problem is that those excess reserves have built up to the extent that they have because the banks were bailed out of bad business loans that should have never been made in the first place. Furthermore, given the very poor outlook for any kind of meaningful economic expansion for the foreseeable future, banks will be quite content holding onto that cash and keeping it at the Fed. In fact, Bernanke could probably refrain from paying any interest rate on that money because it’s a safe place for banks to keep that cash and avoid the risk of that money not being returned (unlike general business loans, money market funds, commercial paper etc.). Of course, Bernanke being an ivory tower academic and nothing more, is clueless about the nature of this dynamic. But you can see why this policy tool is useless. Would you want to keep your cash in a place where you know you can get it back, or lend money to a real estate developer or hamburger franchiser right now? How about a Ferrari dealer who wants to expand in Ohio? The point is that IF the time comes when the economy offers favorable risk/return lending opportunities to the banks, they will unleash those excess reserves and Banana Ben will have no control using his sleepy excess reserve interest rate tool.

  2. 2 DaveInDenver

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    Ya, I thought about including a discussion about how he should raise the reserve requirements for banks, but my post was getting kind of long. In thinking through it though, my bet is that the bulk of those excess reserves are from banks who were bailed out and have benefitted from Bernanke’s mortgage and Treaury asset purchase program. Raising the reserve requirements to the degree which would “absorb” the excess reserves might punish the smaller banks who have not benefitted from the Fed’s generosity.

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