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As a response to the credit crunch the Federal Reserve, along with all major central banks around the world, stepped in and injected an astronomical amount of liquidity into the US banking system. Usually this results in excess reserves that eventually find their way into the real economy or are mopped up by the Fed as their need recedes (and to prevent inflation).
But that isn’t happening now. As you can see from the chart below, aggregate excess reserves in the US banking system peaked in late 2008 and have been fairly level. They are once again approaching $1 trillion dollars. What is more astonishing is just how much of an excess this really is:
But what is really going on? and of what significance, if any, is this?
Not surprisingly, the New York Fed is taking the side of the bankers and arguing against Econ 101 (monetary multipliers) and all manner of common sense to arrive at a conclusion that all is well after all:
While the level of required reserves may change modestly with changes in bank lending behavior, the vast majority of the newly created reserves will end up being held as excess reserves regardless of how banks react to the new programs. In other words, the substantial buildup of reserves depicted in the chart reﬂects the large scale of the Federal Reserve’s policy initiatives, but says little or nothing about the programs’ effects on bank lending or on the economy more broadly.
The above excerpt is from the comment titled “Why Are Banks Holding So Many Excess Reserves?” and is written by Todd Keister and James J. McAndrews. You can download it from the NY Fed’s website. It concludes that:
The dramatic buildup of excess reserves reﬂects the large scale of the Federal Reserve’s policy initiatives; it conveys no information about the effects of these initiatives on bank lending or on the level of economic activity.
Source: Gluskin Sheff
1 For Me; 0 For You
Banks are not lending because they are following the simple forces at work. They have no compelling incentives to lend and many incentives to sit on their cash. For starters, in October 2008, for the first time ever, the Federal Reserve started to pay interest on reserves. That itself is of course a powerful reason to hold as much as you possibly can. After all, if you can earn a return without taking absolutely any risk why wouldn’t you?
The FDIC is providing an even more lucrative reason for banks to hold large reserves. As a banker from California commented to Mish recently, a healthy balance sheet puts banks at the top of the list to receive the loans and deposits of failed banks. Strong banks therefore are competing with each other to receive the spoils of their fallen peers.
Again, why would you go through the costly and risky endeavor of actually lending money to people and businesses when you can just sit back? Here’s a list of failed banks from FDIC’s website. Last week 5 failed - I mean, 5 lucky “healthy” banks won the FDIC lottery.
The end result is that what we end up with is larger and larger institutions who are playing a shell game to further their own ends without really playing a role that contributes in a positive way to the general good. Banks grow larger and larger by feeding off the faltering, smaller, banks. So we have a concentration of risk instead of diluting it.
Actual lending and credit which is in reality the reason why these institutions exist in the first place have become a quaint sideshow. Instead they are now glorified hedge funds suckling at the teets of government. Privatized profits, socialized losses. And the bonuses keep on flowing at an ever growing rate. And to top it off we have government institutions like the Federal Reserve, FDIC and the Treasury who are cheering on the whole show.
If this was a movie we’d all walk out. Suspension of belief for entertainment is one thing, this is just nuts.
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