Fed paying banks NOT to lend!!!

When we learned that Citibank, Bank of America, et al. all had negative equity but Washington refused to restructure them (because, they claimed, absurdly, improved economic conditions would rescue bank balance sheets… as we headed into a severe recession), I wondered whether the secret Obama/Fed plan was to shovel free money to mega-banks… enough money — both above and below the table — that they could become “profitable” and puff up their stock prices from the $0 they were worth absent government gifts.

TARP was a step in that direction. So was the still secretive Fed program that let banks unload TRILLIONS of dollars of junk assets on the Fed in exchange for vaults full of crisp, clean $100 bills.

We may today have discovered another way the Fed is shoveling cash to its big bank friends: paying banks high rates of interest to park their money at the Fed rather than lend it out to businesses and consumers.

This has not been confirmed, but statements by Federal Reserve Chairman Ben Bernanke plus a HUGE increase of bank money parked at the Fed strongly suggest the Fed is paying banks not to lend.

Bloomberg reports:

[B]anks’ excess reserves at the Fed rose to a record $877.1 billion daily average in the two weeks ended May 20, from $2 billion a year earlier. Excess reserves — money available for lending that banks choose to leave with the Fed instead — averaged $743.9 billion in the first two weeks of this month.

What incented banks to increase their Fed deposits from $2 billion to $877 billion? Apparently, high interest rates:

Reuters reports:

By setting [a high] interest rate on reserves the Fed essentially creates a magnet for banks to place those reserves with the Fed rather than lend them out into the financial system — creating a floor under short-term market rates.

This is because banks generally will not lend funds in the money market at a rate lower than they can earn risk-free at the Fed.

“Raising the interest rate paid on balances that banks hold at the Federal Reserve should provide a powerful upward influence on short-term market interest rates, including the federal funds rate, without the need to drain reserve balances,” Bernanke wrote.

So, strangling the economy during The Great Recession is a good thing, Mr. Bernanke?!?!?!

The Fed’s argument is that interest rates are at record lows and must rise. But rates aren’t really at record lows because businesses and consumers can’t borrow at anything like the official near-zero rates. Bribing banks not to lend raises the risk-free interest rate banks receive (which appears part of the master plan to bailout banks with under-the-table money), and it raises the already much-higher rate at which businesses and consumers can borrow.

If the Federal Reserve cared about unemployment — officially nearly 10% but really much higher if you include the underemployed and those who want work but have given up looking because prospects are so bleak — they would be encouraging lending.

Instead, they’re claiming the inflation boogey-man is just around the corner. That’s their “justification” for paying banks NOT to lend during The Great Recession!

Posted by James on Thursday, July 23, 2009