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.

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.

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.

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.