Today the Federal Reserve created $12 billion dollars, giving it to an unknown individual, bank, or country in exchange for mortgage-backed securities. This happens all the time in various amounts.
The real kicker however, is when that money gets deposited into a bank, the bank can then lend $120 billion dollars because of our system of Fractional Reserve Banking, thus increasing the total money supply by $120 billion. Fractional Reserve Banking is an inflation multiplier.
Turns out Wall Street and the big banks have already found loopholes to get out of the regulations the President is creating to contain them.
"A person familiar with the operations of one big Wall Street bank said it expects that new regulation will affect less than 1% of its overall business." - Big Banks Have Already Figured Out The Loophole In Obama’s New Rules
If we really want to rein in the power and influence of these big banks, we simply need to let them fail. And we can do this by getting rid of their safety net, the Federal Reserve. Obama and Congress may have bailed out Wall Street (Bush probably would have too), but what keeps banks from becoming insolvent every day is the Federal Reserve. If a bank loans out too much money, the Federal Reserve is always there to buy assets from them, creating money (and inflation) and put said money in their account.
Make banks survive on their own without government welfare, then we would see their true power wane.
Only one president in the history of the United States paid off our nations debt. Anyone know who it was? Andrew Jackson, our seventh President.
This week I listened to an excellent book, "The Case Against the Fed" by Murray N. Rothbard. I highly recommend it if you want to understand our current economic problems. I'll post links to the mp3s later. It's all online and free at the Mises Institute.
You've probably heard me talk about the Federal Reserve. Ron Paul, a Republican representative from Texas, wants to do away with the Federal Reserve. In an attempt to expose what they do behind the scenes, he has introduced a bill that has over 2/3rds of the House in support, and 1/4 of the Senate in support that will audit the Fed, letting us know which banks (foreign and domestic) receive virtually free loans so they can continue their reckless risk taking while tax payers pay for it through debt and inflation.
Wall Street and Wall Street Banks are terrified that this might actually happen, and they might have to be responsible for the first time in almost 100 years with their lending practices.
Douglas A. McIntyre writing for 24/7 Wall Street wrote a piece very critical of the idea that we should know who our money is going to and which banks we constantly keep afloat due to their poor lending standards and poor banking practices. He inadvertently mentions these fears and outright tells us that banks are constantly on the verge of insolvency. Were it not for the Federal Reserve, the big banks on their "high wires" would fail.
The Fed's argument against Paul's proposal is simple and defensible. The agency keeps important secrets including which large banks need substantial amounts of money during hard times. The public cannot know these details because it would cause a national panic. What if it was common knowledge that Citigroup (NYSE:C) had borrowed $100 billion in emergency funds from the agency? Citi's stock could lose 90% of its value in a day. The Fed wants to keep secrets to prevent runs on major banks. The Fed, its defenders would argue, is the home to impartial financial minds that have the best interests of the nation's credit system at heart. The average person would not be able to stand the strain of watching the agency's daily high wire act up close, certainly not during a crisis.
-The Federal Reserve Vs. Ron Paul
His article goes on to explain that we are simply "to stupid" to understand the complexities of banking and economics. I'll tell you right now, it's not that complex. They know they are bad at banking. They know they take too many risks. And they know that if they were exposed to true market forces, Wall Street would be worthless.
This is why we need Ron Paul's Audit the Fed bill to pass in it's original form. This is why we need to End the Fed. It's not rocket science, it's actually quite easy to understand. If you're interested, start here.
I was reading the following article and recalled another one recently that suggested a reason for the low interest rates that helped fueled the housing bubble.
Money from countries with trade surpluses like China has flowed into the United States, a factor thought to have contributed to the low interest rates that helped feed the U.S. housing bubble.- Bernanke urges US to cut budget deficit
I don't understand why reporters are saying this. The Federal Reserve sets interest rates! They are at near zero percent right now, not because of China or any other country, but because of the Federal Reserve! The Federal Reserve played a major role in the housing bubble. How can they not understand this basic fact of our economy?
The author, Jeannine Aversa, even mentions the manipulation of interest rates by the Fed in the very same article, "Bernanke and his colleagues last month held a key bank lending rate at an all-time low near zero and pledged to hold it there for an 'extended period.'" UUUUHG!!
With all the big banks getting bailout money, they have been doing quite well. Unfortunately it has come at the expense of the little banks. After all, the big banks can borrow directly from the Federal Reserve at a near zero percent interest rates. It's free money, it's not theirs, and if they lose it they know they will get bailed out. When you're risking someone else's money (no risk), you can offer whatever kind of deal you want. Little banks can't do that because they know they won't be bailed out. As a result, they offer fewer loans, but they still have to compete. This means they have to lower their lending standards, loan money at the same rate, and if a few too many defaults happen they go under. They are at a big disadvantage and are losing. As proof of this, the three biggest mortgage lenders -- Wells Fargo, Bank of America and JPMorgan Chase now account for almost 52% of new home mortgages in the first half of 2009, compared with only a 37% share in 2007 (according to the article below).
So to try and keep the little guys from dying off, the government has decided to give them money as well. See Fannie, Freddie Aid Mortgage Banks: Report.
Fannie Mae (FNM Quote)and Freddie Mac (FRE Quote) are in the process of introducing a program that will help independent mortgage banks acquire short-term credit for financing home loans and also reduce risks these banks are exposed to, a report says.[ . . . ]
The objective of the program appears to be aimed at supporting independent mortgage banks which have either gone out of business or are losing market share to better-capitalized firms over the past two years.
The Federal Reserve has already socialized failure for the large banks, spreading the losses to tax payers while letting the banks reward themselves with money they make off their free loans. The great bank welfare program of the early 21st century is having consequences that are a little too obvious and visible (small banks die, large banks make billions) for them. In order to keep up the appearance of competition, their solution is to give risk free money to all banks, all in the name of helping the consumer. It's good work if you can get it.
The end result will ultimately be a faster transfer of wealth from the lower and middle class to the top 5-10%. It happens through higher taxes in part, but mostly it occurs from inflation. The money being given to these banks is created by the Federal Reserve. Every dollar created makes our existing dollars worth less. Eventually, people won't want our money anymore (see Inflation On The Way). If they do do accept it, they'll want a lot more of it.
Lawmakers would curb Federal Reserve's power, not expand it
"The Fed is running into unprecedented opposition on Capitol Hill," he said.Critics have complained that the Fed faltered on all fronts leading up to the crisis. Years of low interest rates helped fuel the housing bubble, and lax oversight of financial institutions allowed consumers and banks to engage in increasingly risky behavior.
"If you look at the record here of the failure of the regulatory bodies . . . all roads seem to lead to the Federal Reserve," said Sen. Richard C. Shelby (R-Ala.).
The Fed is being hit from both sides of the ideological spectrum.
The same day I receive "End the Fed" by Ron Paul, Barney Frank announces the House Financial Services Committee will hold hearings on H.R. 1207,
Ron Paul's bill to audit the Federal Reserve. The hearings are scheduled for Friday, September 25th at around 9:00 am.
House of Representatives to Hold Audit the Fed Hearings
I may have to set my DVR to CSPAN!
On a related note (since unemployment is directly linked to the Federal Reserves policies), I heard NPR today talking about how unemployment is nothing like it was during the Great Depression, citing unemployment statistics of 25% unemployment then compared with 9.7% today. NPR is comparing apples and oranges. Unemployment as measured during the Great Depression is actually at 16.8%. See the U6 line of the government's numbers. I realize not many people understand how the numbers have been manipulated, but this is truly poor reporting. Taking what the government says at face value, without digging under the surface at all.
Instead of me explaining it again, I'll let Peter Schiff do it.
It all reminds me of a quote from John Adams, Second President of the United States.
"All the perplexities, confusion and distress in America
arise not from defects in their Constitution or Confederation,
nor from want of honor or virtue, so much as downright ignorance
of the nature of coin, credit, and circulation."
I just found this article, The Next Financial Crisis, It's coming--and we just made it worse.
It's about the Federal Reserve, interest rates, and the problems associated with bailing out banks that take huge risks. It briefly examines the history of the banking system, Fed's role in the Great Depression, and how through successive lowering of interest rates, it has set up the economy for worse and worse financial crises. This quote from the article seems to say it all...
Over the past century, we have moved away from a system where bank shareholders and senior executives paid dearly for bad management--and toward a system where fired bank bosses make off with fortunes or launch brilliant political careers. No one is on the financial hook, other than the taxpayer. Consider the case of Citigroup, a seriously troubled bank. Chuck Prince, the CEO who fell flat on his face, walked away with close to $100 million. Win Bischoff, former chairman and interim CEO of Citigroup during the debacle, has just been appointed chairman of Lloyds Banking Group in the United Kingdom--reflecting the high esteem in which he is apparently still held. And Robert Rubin, Treasury secretary under Clinton, made over $100 million as board member and chair of Citigroup. In an interview late in 2008, he brushed off any responsibility for the mismanagement of anything. And so, our recurring financial crises are not isolated random events; they emerge from a pattern of private and public sector behavior. Enabled by the Fed, our system's tolerance for risk is out of control. This is an increasingly dangerous system. It is only a matter of time until it collapses again.
On this blog, I point to a lot of dire news and have a pretty negative outlook on the economy. A lot of people tell me it's not going to be so bad and that I'm too pessimistic. I don't think I am, so I'm going to try to explain where my pessimism comes from. I'll break it up into multiple parts because I have a feeling it will take a while to explain.
To understand what has happened, we first need to understand how the economy is supposed to work. Once this is understood, it's easier to see the problems in our current economy. I'll begin with the artificially low interest rates set by the Federal Reserve. The Fed often refers to interest rates as their primary tool to help "stabilize" the economy. While it may do so temporarily, in the long run it only makes things worse.
The Roll Of Savings
Traditionally, banks use the money we save to lend to businesses. Businesses use this money to create products, replace equipment, or expand their operations. They agree to pay back the money lent to them with interest. Since banks use our money, they pay us a part of the interest they receive. This encourages saving. What is left over is the banks profits. As demand for savings and loans fluctuate, so do interest rates. Let's look at this process in a little more detail.
The Business Cycle
When interest rates are high, it's because bank reserves (the amount of money we save) are low. Banks raise interest rates to entice us to save. Since there isn't a lot of money available, businesses are willing to pay more for a loan, but may borrow as little as possible because of the high rates. Over time as we save more and businesses take out fewer loans, interest rates start to drop. Loans become cheaper and businesses can take out loans to replenish their inventory, replace equipment, or expand their business. Businesses also know that as interest rates continue to drop, we will save less and spend more because it's not as beneficial to keep our money in the bank. Businesses produce more goods and we buy more goods. As we spend our savings, bank reserves begin to drop. As bank reserves drop, interest rates begin to increase, we will begin to save, and businesses take out fewer loans. The fluctuations in interest rates are relatively small, and keep the economy humming along.
Bubbles and Recessions
Sometimes businesses make mistakes and invest money where they shouldn't. For instance, say there is a small town with one restaurant. One day, the circus comes to town. All the workers at the circus and visitors from other towns frequent this restaurant. The restaurant owner makes the mistake of thinking this influx of business is permanent. He adds on to his restaurant and hires full time help in the kitchen. Since demand for his food has increased, he is able to raises prices. Wages for restaurant help may also increase as there is more demand for this kind of labor. When the circus leaves, business drops off. The restaurant must close off the extra seating, lower its prices, cut wages, and layoff the extra workers. Without doing so, he will go out of business. Mistakes happen. When they do, bubbles form. When the bubble bursts, the market corrects itself through a recession.
The Federal Reserve
Bring in the Federal Reserve. For whatever reasons, some economists think it is necessary to keep bubbles inflated. Without doing so, deflation occurs (oh the horror!). In our example, there is downward pressure on prices and wages. Although this necessary correction is healthy for the economy and the restaurant, the Federal Reserve's mandate is to stabilize prices and maintain full employment. To do this, they lower interest rates to encourage consumption. Since interest rates are lower, people will save less and continue to go to the restaurant, maybe even pick up the slack from the missing circus employees. The restaurant will maintain it's higher prices, retain its employees, and keep the entire restaurant open. Here comes the problem.
Because there wasn't a correction and things are going well, the business owner may decide to expand again. Remember, when interest rates are low, businesses see it as an opportunity to invest. Maybe the drop in interest rates was so effective that the remaining people in the town picked up the slack and then some. They continue to spend their savings because it isn't worth keeping money in the bank. Now the business cycle is broken. Consumers are spending more of their savings then they normally would, and the restaurant is expanding it's business. The bubble has been reinflated. Left alone, interest rates will again rise due to less money in the banks. When this happens, the local economy will again contract, except things are now worse then before. The recession becomes more painful.
Cue the Federal Reserve! To keep a worse recession from happening, the Federal Reserve again lowers interest rates. People spend more and business continues to grow. But these interest rate cuts are not sustainable. Eventually, consumers run out of money and enter into debt, and the restaurant is so big, any decrease in demand and there is no way it can keep from going out of business. It must liquidate it's assets and pay off its debt.
This is what has been happening to our economy for quite some time. The Federal Reserve continues to try and inflate our bubbles Instead, it is preventing necessary market corrections.
In my next post, I'll use the housing bubble as a real world example of what happens when low interest rates are kept too low for too long. Part II: The Housing Bubble.
P.S. I should note that the example of the circus is from Peter Schiff's book, Crash Proof. It's a must read if you're truly interested in what I'm talking about.
Even in all my reading, I'm still not 100% sure what exactly the Federal Reserve is or how it works. From what I understand, it's a system of 12 banks with the New York Federal Reserve Bank in charge. But is it a private or public organization?
Recently, the Bloomberg news service sued the Fed under the Freedom of Information Act to find out which banks money was given to and on what terms. The New York Fed responded by saying that it is a privately owned entity so isn't covered under the the Freedom of Information Act. A judge rejected this argument and ordered the information released by Aug 31st. It still hasn't happened. The reason, the Fed Board of Governors says, "We don't control the system of record-keeping in New York" so they can't find out who was given what money. More here.
This is our monetary system we're talking about, the foundation of our economy. Poor monetary policy brought down the Rome Empire, the Persian Empire, the USSR, Germany after WWI, and a host of countries throughout history. And we aren't allowed to see what is happening? The Board of Governors of the Federal Reserve can't find out in a timely fashion, where our money is going? There are 416 small banks on the watch list for failing banks. The Fed only gives money to a privileged few. When these smaller banks go under, the FDIC (read tax payer) buys up all their bad assets, and larger banks buy the good assets for fire sale prices. Shouldn't we know who is benefiting? Who is getting all of this money?
Ron Paul's book, "End The Fed" just came out. It is currently #23 on Amazon's top selling book list. My copy is in the mail, and should be here next Thursday. I can't wait to read this book. Anyone interested in our future, or the future of your children, should do the same. This is an important book.
Ben Bernanke is the head of the Federal Reserve. He, like most of his predecessors (if not all), believes in price stability. No inflation or deflation of prices.
Here is what Ben Bernanke believes in his own words.
"In particular, I will argue for what I believe has become the consensus view, that the mandated goals of price stability and maximum employment are almost entirely complementary. Central bankers, economists, and other knowledgeable observers around the world agree that price stability both contributes importantly to the economy's growth and employment prospects in the longer term and moderates the variability of output and employment in the short to medium term."The Federal Reserve was created in 1913. Here are the price stability numbers before AND after the Federal Reserve was created.
1800-1913: $100 becomes $58.10. Deflation of -0.48% a year
1914-2008: $100 becomes $2124.41. Inflation of 3.25% a year
Although there was deflation prior to the Federal Reserve, something that the Fed wants you to think is bad (do any history books talk about the horrible deflation of the 1800's?), prices were much more stable. So, if Ben Bernanke truly believes in what he says, he should close up shop and dismantle the Federal Reserve. I don't see it happening.
James Bullard, president of the Federal Reserve Bank of St. Louis, wants the Federal Reserve and Ben Bernanke to start thinking about how it will contain inflation now that the economy is showing signs of recovery. Bernanke keeps saying that inflation wont be a problem because once the economy begins to recover, the federal reserve will be able to mop up any excess liquidity with the tools it has at it's disposal. An analogy I like is from Peter Schiff, "liquidity is a lot like liquid, it's a lot easier to spill than to un-spill."
Mr. Bullard wants to know what tools Bernanke plans on using, and how he plans to use them. He's pessimistic such a plan will be forthcoming. "I think I'm an army of one on that,"
Via Bloomberg - Tightening Credit Becomes Bernanke Bind in Bond Purchase Unwind
The problem is that mopping up excess liquidity generally means using the tool of higher interest rates. The more liquidity there is to mop up, the higher the interest rates will have to be. With the goal of keeping the interest rate near zero to help the recovery, this seems like quite the conundrum for Ben. Especially since almost all economists agree that in order to fight inflation, the Fed will have to be preemptive. This means raising interest rates before the recovery is in full swing, but doing so in such a way as to not stop the recovery. Another "tool" the fed has been using is expanding its balance sheet by buying up toxic assets. When it's time to reabsorb the money they spent on those assets, it's going to be very difficult to find buyers for bonds backed by subprime mortgages, auto loans, credit card debt and student loans.
So will the fed have what it takes? From the Bloomberg article..
Don't count on the Fed to get it right, says economist Allan Meltzer of Carnegie Mellon University in Pittsburgh. The central bank has often lacked the resolve to pursue unpopular policies to keep prices in check, says Meltzer, who's the author of two volumes chronicling the Fed from 1913 to 1986.As an interesting side note, since the Federal Reserves inception in 1913, the dollar has lost 95% of it's value due to inflation. With the unprecedented spending by Congress and the Federal Reserve, my guess is Ben Bernenke will not have the willpower or ability to stop the inflation that is on the way."The Fed throughout its history has carried out a strategy of taking care of today's problems, not looking to the future," Meltzer says.