Bernanke says more Fed asset purchases could help

October 4 (Reuters) — The Federal Reserve’s asset purchases lowered borrowing costs and supported the economy, and more buying could further ease financial conditions, Federal Reserve Chairman Ben Bernanke said on Monday.

He leaves out the negative influence of the interest rate and fiscal channel that he wrote about in his own 2004 paper. The economy is a net receiver of interest from the govt and lower rates reduces interest payments from the govt to securities holders. And in this cycle savers lost more interest income than borrowers gained, with the difference going to wider net interest margins for banks, who have no propensity to consume from that interest income.

“I don’t have a number to give you, but I do think that the additional purchases, although we don’t have precise numbers, have the ability to ease financial conditions,” Bernanke said.

Bernanke said he was convinced that the Fed’s massive purchases from March of 2009 until early 2010 had lowered effective interest rates at a time the central bank’s benchmark lending rates were anchored near zero, where they remain.

The buying program “increased the willingness of investors to take a reasonable amount of risk and create some support for the economy,” he said.

Again, he leaves out the fact that all the $50 billion + of annual interest earned by the Fed on its new portfolio of over $2 trillion in securities would otherwise have gone to the economy, but instead is turned over to the us treasury, thereby functioning as a tax.

In September, the Federal Open Market Committee said it was ready to take further steps to help the U.S. recovery if the economy stays sluggish. Reviving the program to buy assets such as U.S. Treasuries seem like a potential step.

In a wide-ranging, hour-long forum with university students in Providence, Rhode Island, Bernanke defended the U.S. government’s often criticized program to support banks during the global financial crisis.

The Troubled Asset Relief Program, or TARP, has turned out to be a ‘pretty good investment” for taxpayers money loaned to banks during the financial crisis is returned with interest.

Many people don’t understand that TARP was designed to help the economy, not the banks, and that the country’s economic downturn would have been much worse without it, Bernanke said.

Nor does he seem to understand it was nothing never anything more than regulatory forbearance, and not a fiscal expenditure. The FDIC, for all practical purposes, already guaranteed all bank deposits should bank losses exceed the amount of the bank’s private capital. So adding more public capital through tarp rather than simply granting regulatory forbearance (along with imposing any terms and conditions the govt might desire) was non nonsensical, politically destructive and divisive, and demonstrative of a complete lack of understanding of the banking system by the entire govt., media, and financial sector in general.

13 Responses

  1. “The FDIC, for all practical purposes, already guaranteed all bank deposits should bank losses exceed the amount of the bank’s private capital.”

    The FDIC effectively puts up capital for dead banks after the fact.

    Treasury did it before the fact for non-dead banks (they’re not dead yet).

    Equivalent forbearance would have required make up guarantees. Otherwise, the stocks would have gone to zero and the banks failed through liquidity crisis.

    With guarantee fees, it’s the same thing as economic capital that earns an all-in rate of return.

    The true technical problem (not the resulting political problem) is in dysfunctional accounting within the budget optics – accounting as well as public opinion not being able to differentiate properly between true deficit expenditures and the TARP capital program as a financial risk asset.

    1. the Fed is there to make sure no bank fails due to liquidity issues. that’s not to say it didn’t take the fed maybe 3-6 months to figure out how to do it. if they understood banking they would just lend fed funds to member banks on demand and move on.

      it was learned a long time ago that the liability side of banking is not the place for market discipline.

  2. I do not know what regulatory forbearance is in a technical sense, but believe it is allowing banks to continue to run with a critically undercapitalized state. Not sure if the big banks were in that state and the TARP website says they weren’t – it was just to allow financial institutions to run smoothly.

    TARP I think was a good thing. It may have been done in a hurry but such things require fast action instead. It brought some confidence in the markets. Just allowing the banks to fail would have been a sadistic thing to do.

    True banks didn’t behave properly, but neither did the regulators.

    Regulatory forbearance is difficult in practice. One can allow a bank to continue but if the whole system is in trouble, its difficult to see how one can achieve that.

    With TARP however, there is some sort of understanding that banks will make good loans at least for some time. In the case of forbearance, there is no way to establish that.

    1. it’s established exactly the same way with regulatory forbearance as with tarp. they were functionally identical.
      as long as a bank can fund itself it can go on as if nothing was wrong.
      just like many of the banks in europe today, and probably the banks in china as well.

  3. Ranaman: The question is not “just let bank fail” vs “bail out bank”. There is huge area in the middle that preserve good business and good public policy.

    TARP should not be judged next to apocalypse. It should be judged compared to reasonable alternative.

    I do not see how predence of TARP bailout will encourage bank to make good loans at least for some time.

    1. One has to look at the situation then and the complex future scenarios. What was the alternative – what would have been the precise forbearance plan ? Imagine 10 banks, 3 well capitalized and 7 nearly undercapitalized. What do you do with the 7 ? Forbearance till what date ? Since there are 7, forbearance till one date in the future for all seven of them or different expiry dates ? What is the guarantee that the equity and the CDS markets do not ruin the banks in the meanwhile ? The point about TARP is that it prevented these things to some extent.

      1. Ramanan:

        A bank, with regulatory forebearance, and access to discount window, can function at any level of capitalization. You put in those two, and you have luxury of time to do whatever you need.

        Many solutions have been discussed here and elsewhere. Even if you take non-optimal solution, it is still better than “apocalypse” scenario of Govt doing nothing.

        There is no need to treat all 7 undercapitalized banks, in your example, the same. And if banks are “ruined” so what? Point is not to protect banks, point is to protect 1) deposits, and 2) ability of credit extension to worthy borrower. both if these are frankly trivial to get.

      2. Zanon,

        Yes I understand that its possible for banks to continue operating with the scenario you propose.

        Yes it comes down to arguing about saving the banks versus other stuff. Plus also consider complications such as details of the insurance. Corporates insured – not sure. Deposits in foreign countries are not insured.

        It takes time to make a new banking system if you let the present banks fail.

      3. it would have looked much like tarp- just tell the banks they can continue to fund themselves (with their sub standard capital) at the fed if necessary and impose the same terms and conditions that were imposed with tarp. tarp did not give the banks anything they didn’t already have. all they needed to continue to function was liquidity which they got from the fed anyway

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