2013 July 02 Tuesday
Why Did Federal Reserve Reduce Bank Lending Incentives?

The Fed pumped up the money supply via quantitative easing (QE - the large scale purchase of bonds) . But at the same time it started paying interest to commercial banks on excess reserves deposited at the Fed. This cut the incentives of commercial banks to lend. Why? Martin Feldstein (a very major economist) pinpoints that Fed policy change as the reason why QE did not cause massive inflation. Read this and try to figure out the Fed's motivations.

The stock of money that relates most closely to inflation consists primarily of the deposits that businesses and households have at commercial banks. Traditionally, greater amounts of Fed bond buying have led to faster growth of this money stock. But a fundamental change in the Fed’s rules in 2008 broke the link between its bond buying and the subsequent size of the money stock. As a result, the Fed has bought a massive amount of bonds without causing the stock of money – and thus the rate of inflation – to rise.

Is QE just a scheme to increase bank profits? What game is the Fed paying and which elite interests is it serving?

What are America's elites doing aside from enriching themselves? What is their game plan? Is the Fed just trying to prevent the banks from collapsing? Or is the Fed serving the super wealthy?

Share |      By Randall Parker at 2013 July 02 09:55 PM 

C said at July 3, 2013 2:10 PM:

It kind of strikes me as strange that they'd want there to be so much excess reserves available to banks. Is it at all possible they're going to do away with interest on excess reserves, causing a huge "loan glut" and a temporary return of the early 00's easy money? In such a situation, it may eventually stress the supply of money available to the public to pay all these loans back, causing another cascading crash, and another opportunity to buy up distressed assets at pennies on the dollar.

I don't know, I'm really a rank amateur when it comes to economics, but it still seems volatile to have that much slack to loan out in an instant. Is there another possible incentive I could be missing?

Sam said at July 3, 2013 7:19 PM:

I followed your link and liked one comment there explaining the abaence of inflation,
"...commenter Frank O'Callaghan

Question: “Why has the Federal Reserve’s printing of so much money not caused higher inflation?”

Answer: POVERTY.

The US has created huge poverty in what was once the world's most prosperous society. The wealthy have so much that they have few -if any- unmet needs or desires..."

This seems reasonable to me. The banks are holding reserves from the Fed but all the money created by the Fed goes to:
1. Paying interest on the debt.
2. Welfare programs that only meet basic needs.

I'm not friend of the Fed but you must admit that they have been navigating this financial morass skillfully. Not too much inflation but some growth. Left unsaid; were they responsible for the whole mess in the first place? I was convinced that the whole economy would roll over like a beached whale in 2012. I readily admit that maybe it's a more sophisticated way of screwing us that I haven't penetrated the exact mechanism yet.

Randall Parker said at July 4, 2013 11:42 AM:


The idea of setting up for a sudden huge bout of inflation is interesting. Hadn't considered that. It is like building up a large amount of water behind a dam and then, oops, the dam broke. Would leave them with plausible deniability.


My suspicion: this is a mechanism to subsidize a bunch of big underwater banks to bring them back above water.

REN said at July 4, 2013 7:16 PM:

There are only a few economists who understand balance sheet recessions, and even fewer who understood how QE would play out. Modern Monetary Realism is probably the best school for understanding the mechanics. www.pragcap.com In general, economics is a failed profession, and most economists are dogmatic in promulgating lies they were taught in school. Feldstein’s confusion is palpable, as he gropes to understand what others have understood for many years.

The FED creates money on its digital keyboard. Let’s call this money type “digital money.” It is then spent into the reserve channels of banks. Banks use reserves for mediating credit loans across their private banking system. Banks can hold “near money” instruments in their reserve channels, and they do this to earn some usury gravy. (Usury and interest are the same in my definition.) Near money instruments are TBills, bonds, mortgage backed securities, or anything that is fairly liquid – that is, can be converted to money. The reserve channel of banks has rules that govern what money or near money types can do while there. Banks want reserves to make new loans, and they need reserves to settle imbalances across the private bank system. If banks don’t have reserves, they have to pay interest to buy them on the overnight market, or at the FED discount window. If they have to buy extra reserves, they pay more and loose profits.

Private Banks create a form of money when they make loans. This banker credit money disappears from the money supply when the loan is paid down. An imbalance occurs when a loan is taken out in Midland Texas, and the new banker credit money is deposited in Peoria. Reserves are needed to mediate this imbalance. Private bankers are in the business of getting the population into debt, this in order to make usury profits on loans. Private banking business model is one of spreading debt in the form of new loans.

When the FED creates its digital money from nothing, they then buy a reserved instrument from one of the private banks in their system. It is an asset swap, with Fed digital money swapping for a TBill or whatever else is in the bank’s reserve channel. The bank gets new digital money, which bears no interest, and the FED pulls the near money “asset” onto their books. The asset is seen as having support now, as money is buying it. Bond holding banks are made secure, as their formerly declining assets now find support. The private banks books are made whole by the FED’s digital money creation.

The FED can also buy bonds on the secondary market, usually through their open market operations team. The secondary market is NOT a reserve loop of banks. Anybody can buy and sell in the secondary market. When the FED spends its digital money into the secondary market, a bond holder trades his bond for the new digital Fed money. The FED’s balance sheet grows with the instruments. But, it is important to remember the digital money was created from nothing.

Bond holders by definition are holding bonds because they don’t need money to spend. So giving them money, means they will look to buy other interest bearing or speculative assets. Hence, the rise in “gold” prices, and as well, banks were engaging in a carry trade, financing other countries with new low interest loans. QE money found people (bond holders) who had no interest in spending the money into the real economy.

In the U.S., the working middle class was/is in balance sheet recession. The housing bubble was private bank credit money (loans) created against land/housing and coinsured by AIG or government (Fannie/Freddy). The coinsurance was allowed under Graham/Leach/Blily act, and helped turbo charge the bubble. A banks asset (your house) looks good on the double entry ledger, especially when said house or land is also insured. Ninja loans (no income no job) were rampant, thus driving up housing assets. FIRE sector (finance, insurance, and real estate) are working together as a team to create new loans.

The housing asset class was driven up in the bubble faster than real wealth creation, despite the communications high tech revolution. What cannot go up forever, won’t, and the housing bubble was false economics. New loans pushed the housing market, making more credit loans in positive feedback loop. This false economics is a function of bank money, which comes into being from nothing against assets, usually housing and land. 97% of the money supply is created with hypothecation in alignment with FIRE sector. When the bubble collapsed, the double entry ledger remained, demanding to be paid. Again, when credit money returns to the ledger, it disappears… a positive number meets a negative liability. This drains the money supply, causing a depression.

So, the people who needed money, the working class, to pay their debt loans were not the ones to receive it. Instead, new digital money from the FED went through a sieve, as it funded asset swaps in reserve channels. Some digital money leaked out to bondholders and MBS holders in the secondary market. This digital money goes on to be speculated in the stock market, and also seeks out usury returns if it can get it. When the working class is in debt, they are reluctant to take out new loans. It is important to remember who is holding the money, the money type, and the path it takes.

Think of the QE money as swirling in a path that does little economic benefit, with some leaking down to a lower loop (the real economy) to be used to pay off debts. The large flows of money in offshore accounts and moving around the world are former bondholders looking for usury gravy from the real economy. The QE mechanism has turbocharged a financial oligarchy to take rents on the productive. The QE money would have been better spent by simple transfers to working class. But, then the working class would have paid off their “debts”, and hence banks would have no usury income. We can’t have that now can we? The credit creating banks will continue to fund economic departments and convince politicians via bribes that their double entry credit is the way the world money supply should work.

REN said at July 4, 2013 9:57 PM:

The QE mechanism has asset swapped TBills, bonds and Mortgage Backed Securities onto the FED's ledger. The MBS needed to be bought up because Sheriff departments around the country were investigating the robo signing scandal, and the broken trail of mortgage documents. Many foreigners held MBS that were sold under false pretenses. So, there were many compelling reasons for doing a QE on MBS: 1) Eliminate the evidence by paying off the MBS holders 2) Pump FED digital money into the housing sector to re-inflate property values. This is a false wealth effect, where the homeowner feels richer even though his wages haven't increased. 3)Former Bond holders (MBS pay interest like a bond) will turn around and speculate with their digital money in order to earn "interest" somewhere. This is usually the stock market.

Every year the FED has to rebate excess profits to the Treasury. Since there is no audit, there is no real knowledge of where the profits went. The FED is holding many "securities" on their books and hence is sucking in interest/usury.

What to do? If the FED sells the "instruments" back into the market, it will drain the money supply. The money supply for working class is already under drain pressure in order to pay off double entry ledger "credit" from the housing bubble (balance sheet recession). Give the government the "profits?" The FED's allegiance is really to its owners, the private banks. The FED plays a double game, government must be under control in order to backstop "credit" creation at private banks. The double entry mechanism is inherently unstable, especially with compounding usury as an exponential function. Digital money creation at the FED needs to be an necessary ingredient to keep the confidence game going. The other options are to collapse the economy in a depression, and then grab housing assets that have now become debt free. Then import new people to start the debt peon cycle again.

Government could step up to the plate and issue money debt free into the economy, where it goes on to pay down the private ledger - thus wiping out private debts. Or, debts could be forgiven. Or, we could have State Banks like China, who forgive debt loans on a regular basis, thus making real money that can "float" in the economy debt free and without cost. In other words, when credit money made as a loan is released from the obligation to return to ledger, it becomes money. It changes its nature as the path and force vector have been removed. But then, the private bankers and their captured economists will never admit to these realities.

The bulk of all lobbyist money comes out of one zip code, the financial district in New York. That should tell you all you need to know.

REN said at July 5, 2013 2:16 PM:

"As a result, the volume of excess reserves held at the Fed increased dramatically from less than $2 billion in 2008 to $1.8 trillion now. But the new Fed policy of paying interest on excess reserves meant that this increased availability of excess reserves did not lead after 2008 to much faster deposit growth and a much larger stock of money."

Bank reserves are denmominated in dollars after a QE swap. It can be no other way. The FED creates digital money and swaps for the bond/Bill/MBS. The FED then owns that instrument, not the private bank. The instrument moved from the private banks ledger to the Feds ledger. These new dollars do not make the bank any profit, so said bank may then on-buy new bonds etc. in the secondary market. Dollars are not interest bearing, they are simply demand to the bearer.

The bond holders are made whole with money seeking said bonds. At the same time, bond prices in the market find support through Open Market action. The rules for Bonds are price up, interest rate down. Buying the bonds keeps the price up, and the interest rate low. Low interest rates then induce people to take out new bank loans, even though they are in debt. Or, people can refinance their pesonal debt. Even with low rates, there is little incentive for people in debt to take out new loans. The money supply that most people use, is draining and disappearing as they pay off their loans. Bond price also signals the health of the dollar. If it is high, then that signal says the dollar is strong. Of course, the bond price is artifical as it is new digital money seeking it out.

Banks have always kept their reserves, including the excess at the FED. It is something like an excel spreadsheet. Banks don't physically move money about, they move digits in a computer. All banks have something equivalent to a savings account and a checking account at the FED.

The bond holder may demand interest from the person they purchased it from. If the FED buys bonds from bank reserve channels, they (FED) own the bond, and can demand interest usury from a private bank. IF the FED chooses to send that money back to the bank, that is their business. It is plausible and likely the FED is doing this in order to keep private banks afloat, as their "business model" does not work during a balance sheet recession. The FED already controls the overnight rate via repos and reverse repos, effectively controlling the reserve channels.

Remember, the idea of the FED's QE is to actually put money into the economy, support bondholder elites, and to induce sheeple into new debt formation through new loans. If the FED drains usury to pay for the bonds from a private bank, that is contrary to the purpose of QE.

If the FED buys bonds on the secondary market (not the reserve loop of a bank), that usury profit goes to the FED. The FED may then pay their profits back to the Treasury, or keep it hidden in their slush funds.

Without discussing balance sheet recession, or the nature of people's private debt, Feldstein does a disservice.

Check it out said at July 5, 2013 5:06 PM:

"Is QE just a scheme to increase bank profits? What game is the Fed paying and which elite interests is it serving?"

Well, this means that it's going to be really ugly: unemployment, poverty, demonstrations and all sorts of thefts, burglaries and robberies.

The Fed buying massive amounts of bonds is the same as trying to disguise the huge debt we're into, as if nothing was happening. It's a little like making your children believe that the house is clean by hiding the stinky dog's shit under your carpet. Fed is trying to make people believe that the problem is going to end by wishing it away. This is starting to stink really bad. And when something stinks that bad is because it started decaying a while ago.

Things are going to get even worse. The Fed has destroyed the economy -or has failed to do anything right-, now it is insulting and mocking the general public. If not already too late, it is time to really consider getting the hell out of the U.S.

Sam said at July 12, 2013 12:03 AM:

What I don't understand is where all the money the Fed paid for the bonds and bad loans the Fed bought went to. I'm assuming that the money is kept by the Fed as excess reserves. The Fed paying interest to the banks on this money due to the new rules. If so we can at any time have everything in the U.S. snapped up by the banks with all this money. This would also cause huge inflation. The whole thing is a ponzi scheme.

Sell $1,100,000 bonds at 10% interest, 10% interest used just as an example, to get $1,000,000 cash. How to pay off the extra $100,000. Sell more bonds with more interest. A child would be confused because a child would not think adults would do something so stupid.

What is more important is how do we end this mess. With the present NSA blackmailed congress we have no chance in ending the Fed. If we could end the Fed maybe keep the bonds already bought. The Gov. prints free money, unencumbered by debt, slowly re liquidating the economy. Have to be very careful about inflation. Maybe rules could be made on how much money the banks could have to loan from the excess reserves they have at the Fed to avoid inflation.

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