I have to address a few common misconceptions about the Federal Reserve.
1. The Fed is *not* giving “handouts” to banks. What’s happening is that banks are holding all these junk bonds that they can’t sell, because they’re junk. The Fed can’t use those as collateral because, well, they’re junk. What the Fed *is* doing is taking those bonds and trading them for Treasury bonds, then having these banks use the Treasury bonds as collateral on loans (which the Fed just extended to 90 days). These loans are paid back. It is not a handout, the Fed is simply loaning money under conditions that it usually wouldn’t.
2. The Fed is not backed by taxpayer money. When the Fed loans out money to banks as described above, there is no taxpayer money involved. Essentially what happens is that the Fed takes some money out of its reserves and puts it in circulation. It’s basically increasing the money supply and putting new money out there. Again, let me reiterate- The Fed does *not* take your money.
3. Yes, the Fed increasing the money supply causes inflation (theoretically), which decreases the value of your money. There are two types of inflation. Demand-pull inflation is caused by too much money chasing too few goods. This is what cutting the federal funds rate (increasing the money supply) creates. This is what the Fed tries to control. On the other hand, cost-push inflaiton is caused by a sharp, sudden increase in the price of a cornerstone good to the economy. This is what happened to the U.S. in the 1970s during the oil crisis, and this is what is currently happening to China because of rising food prices. The U.S. is also sucesseptible to cost-push inflation, especially with rising oil and food prices. Not everything can be attributed to the Fed.
4. The Fed’s increasing willingness to help out financial institutions is neither socioeconomic favoritism nor self-interested manipulation. If the Fed failed to help major banks, these banks would fail, causing the entire financial infrastructure of the U.S. to fail. This is what happened during the Depression.
5. Ben Bernanke does, in fact, know what is happening. Before he was Chairman of the Federal Reserve, he was a very involved scholar of the Great Depression. A collection of his essays can be purchased from here or can be found online with a bit of searching
I hope this puts an end to at least *some* of the irrational anti-Fed sentiment that’s been circulating the internet. I’m looking at you, Reddit.
Even given that all you have said is true, Federal Reserve notes are fiat money backed by nothing.
Comment by cyber_rigger — March 18, 2008 @ 3:06 am
I hate to say that you have a common misconception about the Fed as well. The Fed does in fact take our money (sort of), and doesn’t really have anything on reserve other than stolen property.
The Fed (currently) has the exclusive power to print $100 bills, adjust interest rates, and mandate the fractional reserve ratio. Basically the Fed has the power to make money out of nothing. If the Fed needs money they can print it. Yes it raises inflation, which is why the buying power of a 2007 dollar is worth 4 cents in 1913.
It’s also important to note that the Fed doesn’t make money for the US because it’s part of the government, nor out of the kindness of it’s heart. The Fed is a private bank that loans money to the US at interest. This is why it’s rather dubious that the Fed gets to coin money out of jack sh!t. They (and other banks in the US) get to loan out money that they never had, and the public has to pay it back with interest.
Part of FDRs solution to the Great Depression was to take everyone’s gold from them and hold it in the US Treasury (great idea right). In either 82 or 84 (I forget which) the Regan Administration found by audit that the gold held by the treasury in Ft. Knox is no longer owned by the US but had been taken as collateral against the interest on our currency by the Fed.
The Regan Administration also found that not one penny of any money the government gains through the IRS gets used for anything useful. 100% of all capital gained from income tax goes to directly to pay the interest that the Fed dictates when it “loans” us money. So yes, the Fed does take our money.
Comment by Paul — March 18, 2008 @ 4:06 am
Arscogitatae, I have a question for you:
The Fed increases the money supply at a rate of between 5 – 10% a year ( see http://en.wikipedia.org/wiki/Money_supply ) Please tell me who gets this newly created money. If you say “no one”, please explain a mechanism by which the money supply is increased, but no one gets the money first.
I’ve been studying this issue a lot in the past month. The best answer I have is that the money supply is increased via subsidizing maturity mismatching. The winners are banks, those who borrow, and those who lend short term. The losers are those who lend long term and those who hold currency. The net effect of this is to consistently create asset bubbles and drive down the savings rate. Yes, Fed intervention now will stave off economic collapse. But the problem is entirely created by the Fed in the first place.
Comment by Patrick Fitzsimmons — March 18, 2008 @ 5:42 am
“These loans are paid back. It is not a handout, the Fed is simply loaning money under conditions that it usually wouldn’t.”
That makes it a handout. You’re right, they’re not just giving away money. They’re loaning money using worthless collateral. If some of those bonds turn out to have value, then everything will be okay. But if they don’t, banks can just default on their loans and pass the losses on to the Fed. The Fed is taking massive risk off the banks hands.
“The Fed does *not* take your money.”
Not the dollar amount, no. But by inflating the money supply (check out M2 and M3 at http://stlouisfed.org/) they reduce the purchasing power. So they take away your wealth.
“If the Fed failed to help major banks, these banks would fail, causing the entire financial infrastructure of the U.S. to fail. This is what happened during the Depression.”
This might actually be true, and what it means is that these banks should be nationalized. If the taxpayer is going to assume the risk a bank takes anyway (via Fed bailout), they should gain the rewards of ownership. We shouldn’t privatize profits and socialize losses.
Also, many of the major losses currently being taken are by hedge funds. The public doesn’t need those in any way. While I do have some sympathy for the billionaire who became a mere millionaire after Bear Stearns failed, he’s still doing fine. More importantly, hedge funds aren’t that important for the banking system.
Comment by Enginerd — March 18, 2008 @ 1:01 pm
Obviously, Bernanke’s in-depth studies of the Great Depression have led to the sort of misguided nostalgia that familiarity can bring. He’s “gone native,” but as a historian instead of an anthropologist, which takes quite a bit more work.
/me adds another layer of foil to the hat and another ground tap
Comment by khafra — March 18, 2008 @ 1:16 pm
Saying the Fed isn’t giving handouts to banks is disingenuous. The Federal Reserve system is devised to prop up banks when they are in trouble, because, as you rightly say, if banks fail we have a depression on our hands. Whether it is the banks’ own fault, as it is in this case, matters little. Banks made bad investments in real estate, and now those investments are going sour as real estate prices fall back down to earth. What the Fed is essentially doing is pumping money out in any way it can to try to keep real estate prices stable by inflating the price of everything else up to the level of real estate. Doing so rewards banks and everyone who invested in overpriced real estate at the expense of everyone who didn’t. It is a bailout, plain and simple, not for Bear Stearns or JP Morgan in particular, but for the entire system as a whole.
I personally think that the moral hazard built into this system is responsible for a terrible misallocation of resources — building tens of thousands of suburban monster houses at a time when oil for family transportation is about to become very expensive — and that we ought to design decentralized systems that build on the strengths of modern banking while avoiding this moral hazard.
Comment by Ryan — March 18, 2008 @ 2:32 pm