The Role of Banks

“Cut out the middleman.” Facebook is more threatening than the “occupy” crowd.

Since the seasonal reference to “It’s a Wonderful Life” was late this year, perhaps a second reference is appropriate penitence. The last posting, “If the Plan is Right, Stick to It,” addressed personal financial management. It made the simple point that a financial plan that involves running around like a chicken with its head cut off isn’t the way to a wonderful life. Now it’s time to see what “It’s a Wonderful Life” says about banks.

First thing to note is that the Bailey’s are bankers throughout the movie (technically Bailey Building and Loan is an S&L, a distinction made obsolete years ago). Potter, by contrast, becomes a banker when he “takes-over” a bank during a run. The efforts of hedged funds and private equity funds to buy into banking during the recent crisis are similar to Potter’s “takeover.”

The parallels are interesting, but that was the 1930’s and 2008-2009, this is now. Does the movie say anything relevant to today? It says a lot that is timely. Look closely and the movie says a lot about what banks are and how much power they can have.

The first point is easy to miss. In the picture labeled Scene 1 Potter is describing George’s success at avoiding Potter’s control. It’s a meeting between two bankers. What is easy to miss is that Potter refused a telephone call in order to meet with George. Listen closely: he tells his secretary to “tell the congressman he’ll have to call back.” Potter, who craves power, has political contacts. George, by contrast, runs his bank without such contacts.

Scene 1

It’s telling that a bank isn’t enough for the one seeking power. He needs political contacts. Perhaps banks don’t have that much power. They may just be instruments the government uses. Regulation is simply the government trying to preserve its tool.

The situation represented in Scene 2 contains an obvious fact about banks that the media and political demagogues love to overlook. George is explaining banking to his customers. He is explaining that the bank doesn’t have piles of money “back in the vault.” It has assets. To paraphrase the terms in which George explains banking to a customer, “your money is in your neighbor’s house.”
Scene 2

It’s silly when the media and politicians (and embarrassingly, some economists) say banks are sitting on the money rather than lending it. How stupid can they be? The bank’s business is lending. Banks sit on money only to the extent they are required to in order to meet regulatory reserve requirements.

If you think banks aren’t lending as freely as they should (a belief not shared by The Hedged Economist), you should consider this quote from the March 3, 2010 posting “Regulatory capital and who’s got the money?”
“What we know about reserves is that people lower them in good times and raise them in bad times. We also know this aggravates the cycle. Well, surprise, surprise, governments are people; they do the same thing. Unfortunately, the government has a long history of changing capital requirements in the wrong direction over the business cycle.”

Similarly, if you believe banks lend to the wrong people, look closely at the risk factors assigned to various types of loans (the risk factors determine how big the reserves banks have to hold will be). It shouldn’t be a surprise that a bank that lends to the government doesn’t have to hold as much in reserves as one that actually lends to people.

The picture in Scene 3 was used in “If the Plan is Right, Stick to It” to illustrate a point about George’s situation. But, it has broader implications because it is easy to misinterpret. In fact, George is guilty of the misinterpretation.

Scene 3

While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. Turns out, George is wrong.

Scene 4 and Scene 5 illustrate the truth about liquidity.

Scene 4

Scene 5

Scenes 4 and 5 make it quite clear that Potter, and, for that matter, George aren’t the source of liquidity. George’s comment regarding Potter should sound familiar to those who think banks have money. Yet, the happy ending to the story results from the fact that it’s people who create liquidity and all capital by not consuming everything they earn.

The image of villainous bankers deserves no more attention than the villainous merchant. Intermediaries are hardly powerful or the source of the merchandise they sell. That’s true whether the merchandise is a piece of apparel or a loan. Middlemen whether merchants or bankers have to justify themselves regularly.

The most obvious way to eliminate an intermediary is to just stop using their service. That is happening with banks to the extent that people stop borrowing. It’s even more dramatic when they pay off debts. This, of course, increases the overall savings rate when done with current income. However, if existing savings are used instead of debt or debt is paid off from existing savings, the use of banks can be reduced without much of an impact on the portion of current income the person has to save.

George’s experience raises an interesting issue. Potter, the impersonal investor, evaluates George as a borrower based on collateral. By contrast, the populace evaluates him as an individual. For most of history, the ability to evaluate an individual was the way banks justified their role as intermediaries. (Manual underwriting is the term often used to describe the process). It was a high cost way to allocate capital.

Much is made of the competition between community banks that can “know their customers” and large impersonal banks. The discussion overlooks the broader issue. Just as the populace didn’t need a bank to act as intermediary between them and George, there is always a risk of “eliminating the middleman” if the intermediary can’t justify itself. That is a risk faced by banks large and small.

Large banks depend on scale built around their access to large amount of capital at advantageous rates. In the corporate sector that justification was undermined by the corporate commercial paper market. The large banks have used the systems for consumer credit evaluation to gain the scale they need in consumer markets.

Credit scores, automated underwriting systems, risk models, and numerous other systems were designed to reduce the cost. Many of those systems failed during the financial crisis, but even if improved and refined, the systems represent a shift toward Potter’s model. They facilitate scale, but do it by undermining the traditional justification for the banks’ role as intermediary.

Interestingly, the Potter approach requires a legal system where there is clear title and contract law. In THE MYSTERY OF CAPITAL Hernado de Soto points out how these factors, so necessary for the Potter approach to work, are missing in many parts of the world. In those places, a system closer to the George’s model may develop. However, its cost would always be a limit on the availability of credit to a large segment of the population.
The real threat to banks is technology, not the investment risks the banks take. Using technology, and integrating with Facebook, Lenddo.com has developed a community approach based on George’s reliance on character while offering the potential for scale. Their website describes the approach as “By combining community-based micro-lending techniques with social media endorsements, Lenddo is the first credit scoring platform optimized for emerging markets; specifically, markets where traditional credit scores and collateral frameworks may not exist.”

Lending was once based on character and relationship. Social networks have the potential to restore the sound lending practices of the past. And it looks like it already is starting to happen.

Facebook’s COO Sheryl Sandberg said this weekend in the WSJ interview “We would like everyone who builds products to use Facebook. Our vision is that industries get disrupted and [they get] rebuilt with people at the center. The gaming industry has been really impacted by these social gaming companies like Zynga and Playdom. By putting people at the center, they took a totally different approach to games. We think this will happen to every industry.”

Or, as Facebook CEO Mark Zuckerberg said in 2010, “If you look five years out, every industry is going to be rethought in a social way.”

Social lending has caught on with the Lenddo community in places like the Philippines, but if Mark is right a social approach has the potential for radical improvement over the way US and Western European banks traditionally do consumer banking, which has global implications. Thus, it shouldn’t be surprising then that The Hedged Economist is long Lenddo.com.

If the Plan Is Right, Stick to It

Adjust, but don’t abandon a plan that isn’t broke.

It’s a little late: the annual reference to “It’s a Wonderful Life” is overdue. The first such reference in “Did the repeal of Glass Steagall create big banks and lead to the financial crisis?” was in reference to policy. The next year in “Investing Part 3: Setting the volume” the focus shifted toward personal finance and addressed a more subtle issue than the Henry Potter verses George Bailey confrontation.


This year’s first reference sticks with the focus on an individual’s financial management. The point is simple. If one has a good plan, stck to it.

Aficionados of the movie may recognize the scenes. Just as the run on the Bailey Building and Loan referenced in “Investing Part 3: Setting the volume” contained some subtle points, so too do these scenes.
Scene 1

In Scene 1 Potter is summarizing George Bailey’s current situation in preparation for offering him a job. Listen close and you’ll note that George at age 27 is setting aside (i.e., saving) over 20% of his earnings while paying his mortgage. While the dollar figures are quaint after the intervening seventy some years of inflation, it’s telling.

Potter doesn’t get it. He belittles George’s situation, yet acknowledges the George has “beaten” him and cites the bank run as an example. Potter’s explanation is that George kept his head during the panic.

It just doesn’t occur to Potter that keeping one’s head is a lot easier if one has been regularly saving. That’s a timeless truth. If one has a plan, external events like a panic aren’t what drives one’s actions. George’s plans change throughout the movie, but he changes them because his objectives change (e.g., save his father’s legacy in the building and loan, let his brother pursue “research,” marry Mary, save the building and loan from a bank run, etc.). Yet, those changes are a response to events, not a change in plans due to the latest news.

Fast forward to 2012. People who were saving 20% of their income were less likely to see 2011 as a year in which volatility forced them to adjust their portfolio in response to every shift from “risk on” to “risk off.” Similarly, they probably didn’t experience 2008 and 2009 as a reason to panic. While the dollar volatility of savers’ portfolios may have been bigger, their plans could stay the same. In fact, like Potter and George, they may have seen the recent events as a time to invest. Volatility certainly creates opportunities for the investor, but that’s a topic for another posting. It doesn’t require a new plan to capitalize on volatility.
Scene 2

In Scene 2 George is pleading for a loan from Potter. Many business owners invest everything they have in their business. We learn that George put everything into the Bailey Building and Loan. When Uncle Billy loses a deposit, George has no liquid assets. Concentration and focus are necessary in a business, but as an investment strategy, they create risks one ought to avoid.

Potter, who knows George’s situation, asks what assets George has that can be used as collateral for the loan. George isn’t broke. He mentions a life insurance policy. (It has some cash value. So, it’s what is known as whole life.) The cash value (surrender value) is well short of the amount George needs. Remember he has also been paying a mortgage. He has undoubtedly built equity through payments. It’s also worth remembering his home was bought during the depression and Scene 2 takes place post World War II, so inflation has added to his equity. His problem is the shortfall at the Building and Loan. George has assets, but not the liquidity of cash.

It’s interesting that treating home equity as a liquid asset is never even raised as an issue. Does that represent a difference in financial markets or a difference in how people planned? George put every penny into his business, but he didn’t “bet the ranch” (i.e., use a mortgage to raise capital), quite different from using an equity line to finance consumption. Having a home isn’t a part of George’s plan that he is willing to risk.

While pleading with Potter, George expresses a belief that Potter is the only person with the kind of money (liquidity) George needs. When Potter turns George down, George makes his big mistake.

Scene 3

In Scene 3, having been turned down by Potter, George contemplates letting events determine his action. It takes Clarence Oddbody, Angel Second Class, to show George the folly of letting events determine one’s plan. In the end, George realizes how foolish it would be to let events determine his life. That realization sends George on the path to the movie’s happy ending.

Note to Bloomberg: Sometimes it’s Quite Simple.

Speak up now or focus on other issues where you’re more knowledgeable.

“Bloomberg Can Do Better” and “If Bloomberg Had Done it Right, They Could Have Been Heroes” discussed Bloomberg’s retrospective analysis of Fed policy during the financial crisis. As the titles of the postings imply, their analysis came up short. This blog has often been critical of Fed policy, but Bloomberg is wrong to criticize Fed policy during the liquidity crisis.

During a liquidity crisis success is easy to identify, especially after the fact. BARON’S put it fairly succinctly in “Bankers' Boon: Opening the Spigots Redux.” The relevant quote is: “Turn to the writings of Walter Bagehot, the 19th-century editor who wrote an early treatise on modern lender-of-last-resort theory—the basis for central banking. Bagehot differentiated liquidity-lending by making recipients pay up for the money, guaranteeing swift payback.”

The BARON’S article focuses on current policy. It is as critical of current Fed policy as this blog’s recent posting culminating in “Stimulus Can Backfire: Monetary Policy.” BARON’S focuses on the ultimate reason the current Fed policy is ill-advised: The Fed has tools that can remedy liquidity problems. When the problem doesn’t originate from liquidity, monetary policy can find itself “pushing on a straw.”

In Europe, the liquidity issues are the symptom not the cause. Monetary policy can accommodate a response, but the Fed isn’t the European Central Bank (ECB). Interestingly, the ECB recognizes that monetary policy should be a second tier player. Why can’t the Fed?

Now We Know Who the Rich Are

Forget the 1%. Anyone who expects to retire is guilty

The posting entitled “It’s Easier to Fan Envy than Formulate Policies That Work” noted the tendency for envy to run amuck. It pointed out: “Once taking things in order to give them to the ‘little guy’ is set loose, there’s no telling who will become the ‘big guy’.” That posting used an article targeting teachers as those who should take a hit, but it referenced a previous posting citing a raft of articles identifying various candidates for “big guy” and “little guy” status. It’s such an absurd way for people to divert attention from the failure of their policies.

If one needs confirmation of how unproductive it is and how drastic the policy failure has been, consider this. Liberal commentators criticize of the Bush tax cuts for allowing the rich to keep too much of the income GAINS. Contrast that to now when the issue is who will take the CUTs: taxpayers or government, upper income or users of exemptions (a.k.a., loopholes), “entitlements” or discretionary spending, etc. The total absence of a growth policy is evident.

As some politicians push ahead with the political posturing, pretending that it is the distribution that matters, we clearly should expect them to look for more inclusive definitions of the rich. It’s an inevitable outcome of the failure to develop policies that grow the economy. As pointed out in other postings, absent an inclusive definition of who to target as the rich, the math doesn’t work.

Trying to define the rich is getting increasingly absurd. It’s simple. One can tell whether one feels rich, but that’s more a state of mind than income level or net worth. Most people feel rich when they have what they need and feel secure about being able to continue to have what they need. In “Enough Money for Retirement? Even the Rich Say No,” CNBC illustrates the disasters that spring from trying to judge “rich” for others.

The article quotes the finding that: "Even among those considered 'well off,' many seem to fear a sharp drop in their post-retirement standard of living due to insufficient retirement savings.” The author may not realize the implication. The article is arguing that those considered rich aren’t rich. It shows that whomever is doing the “considering” is wrong. If nothing else, the article makes it clear the author has proven that he or she can’t identify the rich.

But, undeterred by the self-contradiction, instead of pointing out the futility of trying to judge whether other people are rich, the piece forges ahead. That’s when the absurdity really surfaces.
“Other findings of the survey:
• About a quarter of affluent Americans say they are not confident they will have saved enough for retirement, and this is especially true for Americans with assets between $100,000 and $250,000 (33 percent) and women (31 percent).”

Who are the rich in the article? It states: “In the survey, Americans had to have investable assets of $100,000, excluding real estate and other property, to be considered affluent.” Talk about absurd. No reference to employer benefits, ignoring age, no reference to work history and the resulting social security income, and a threshold so low that it includes most people who have planned for retirement (especially those closer to retirement). Certainly, anyone planning to retire and dependent on a 401(k) for retirement should be among their definition of rich. If the value of benefits at retirement is included as investable assets, almost anyone with a defined benefits pension is among the rich. Almost any employer health insurance coverage during retirement would put the person among the rich.

The conclusion one has to reach is that we’ve finally found a definition of rich that is broad enough to make the redistribution math work; include anyone with a pension, anyone with retirement health coverage, and anyone who has planned for retirement.

It’s Easier to Fan Envy than Formulate Policies That Work

Obama takes the destructive path

The article on wealth by age and similar articles cited in “The 99%ers: Part 7” illustrate why limousine liberals can’t get me to buy into their class warfare rhetoric. They all illustrate the problem. Once taking things in order to give them to the “little guy” is set loose, there’s no telling who will become the “big guy.” Yeh, the older generation is wealthier than youth. So what?

Another article entitled “Public School Teachers Aren't Underpaid” also illustrates the problem. Andrew G. Biggs and Jason Richwine conclude: “Our research suggests that on average—counting salaries, benefits and job security—teachers receive about 52% more than they could in private business.”

While most people, maybe 99%, may be in one of the target groups of the so called 99%ers, Teachers are in the crosshairs in this article. It isn’t surprising that people with pensions look like a privileged class to the majority of Americans who don’t have pensions. Many public employees have seen the same thing regarding public sector employer-paid health insurance. It’s so disappointing to see such jealousy. Yeh, teachers benefited from being in the teacher’s union. So what?

None of the articles are surprising, but it’s disappointing when a political party makes it the central theme of their election efforts. What doesn’t seem to change is politicians’ belief that people are stupid. How else can one explain Obama’s quote: “This is not class warfare. It is math.” He’s talking about a tax of undefined size, applying it to the wealthy that is defined differently depending on the audience, and a tax that is so vague there isn’t a revenue estimate attached. That may not be class warfare, but it sure isn’t math.

Maybe he says that because he doesn’t have anyone around to do the math for him, but it’s more likely he doesn’t do the math because his math doesn’t work. Even more important than the fact that his math doesn’t work is his firm belief that the public is so stupid it can’t figure out that multiple trillions of dollars aren’t going to come from taxing millionaires (even if he fudges the definition of millionaire to include people with a $250k or $200k income). There just aren’t enough millionaires by any of his definitions.

That said, whether one favors smaller differences in incomes or rejoices in the diversity of incomes is a normative decision (i.e., a value judgment) that we are all entitled to make. What is disappointing is that one political party has so little faith in American’s sense of fair play and equity, their intelligence, and their generosity. Rather than appealing to what is noble in human nature, they believe their success requires appealing to baser motives, distortions and lying, demagoguery, and cultivating dependence.

It will be tragic if it works for Obama, because he’ll reap the whirlwind. The math won’t go away. There is darn good reason “thou shalt not covet thy neighbors’ …” is one of the Ten Commandments. I just can’t understand why more people can’t rejoice in other peoples’ good fortune.

If Bloomberg Had Done it Right, They Could Have Been Heroes

Bloomberg News Responds to Bernanke Criticism


If the initial coverage had been written with the same professionalism and objectivity as their defense, Bloomberg would not be forced to defend it. The articles, especially “Secret Fed Loans Gave Banks $13 Billion,” read like poorly written editorials rather than serious reporting. For an explanation, see: “Bloomberg Can Do Better”.

On Tom Keen’s midday surveillance today (12/07/11), Bloomberg’s Matthew Winkler defended Bloomberg’s accomplishment in getting the information . As pointed out in the posting cited above, there is no doubt Bloomberg provided a public service by forcing the issue. However, as Mr. Winkler pointed out, there is an important issue that needs to be addressed: When should detailed data on actions taken during a liquidity crisis be disclosed? Bloomberg’s coverage could have contributed to that discussion. Unfortunately, the editorial tone of their coverage probably discouraged serious consideration of timing.

Their defense is factually correct, but misrepresents the lack of objectivity of their coverage. Rather than go through their defense point-by-point (something anticipated fairly well in the initial posting), I only request that they reread their coverage and ask themselves one question: Can Bloomberg do better? I believe so, or I would not be writing this.

Bloomberg Can Do Better.

“Secret Fed Loans Gave Banks $13 Billion,” where there’s no secret or gift.

Bloomberg must have spent a good deal of money forcing the release of the information used for the article. They seem very determined to make a story out of it. Unfortunately, although very interesting, what they found is far from headline material. Somewhere in the business section seems appropriate. Since the business section is Bloomberg’s bread and butter, it seems a good fit. However, the article doesn’t fit. It seems to have been written more to justify their effort to get the information (a definite public service by Bloomberg) than to present what the data show.

To illustrate why the article doesn’t fit as serious analysis, a few points are worth noting. The article’s use of terms like “bailout” when referring to loans might lead one to conclude that Bloomberg looks on loans as a gift. We all know better. Bloomberg isn’t a light weight when it comes to understanding the importance of financial data. The bond market is home turf for Bloomberg. Yet, the article leaves the impression of having been written by a backer of Ron Paul who objects to the Fed acting as a lender of last resort during liquidity crises. That’s unfortunate because the article attempts to raise two serious issues: were the loans mispriced, and should they have been disclosed sooner?

The Prices Charged for the Loans:

The first major issue is awkwardly implied by the title. While erroneously presenting it as a gift (i.e., gave banks), the article actually embodies a useful, but debatable, effort to determine whether the loans were mispriced. There are two problems with the effort:

First, someone should have reminded the author of the fact that the Fed essentially sets short run interest rates. The crux of how the Fed does it is by lending and borrowing at their target rate (technically they do it by buying and selling assets). Thus, the notion that they lent at below market rates is absurd. They’re trying to set market rates.

Second, during a liquidity crisis the Fed’s rates SHOULD differ substantially from what would exist absent their action. The mispricing of liquidity IS the problem they were trying to address.

Lest one conclude from these comments that the entire exercise was a wild goose chase remember the comment that getting the information was “a definite public service by Bloomberg.” Nothing said above gives the Fed a free pass to drop money from helicopters, to quote Ben. The Fed’s setting of interest rates is serious business. During a liquidity crisis it is particularly venerable to screw-ups.

So, the serious issue is did the Fed screw-up? At first glance one might conclude that the author is obfuscating the issue to facilitate a scandal-sheet-style presentation. It’s hard to figure out exactly what the data show because of the reporter’s editorializing. The article says “required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day.” But, at another point, it says “Fed had committed $7.77 trillion as of March 2009.” So, it isn’t exactly clear how much the Fed had out working for it on loan. My understanding is most of the loans were overnight repo- like arrangements. Thus, my guess is that the $1.2 trillion was a max.
Either way, if it only left $13 billion on the table, that looks amazing.

Again though, it isn’t exactly clear what the article means by “$13 billion of income by taking advantage of the Fed’s below-market rates.” I find it hard to believe the implication of $13 billion on $1.2 trillion. Given the way the Fed was pumping out liquidity, if they only left 1 percent on the table, more power to them. That, however, isn’t the way to look at it. If the loans were only earning a fraction of a percent, being off by 1 percent is a pretty big miss.

The bigger problem is the way the article tries to measure money left on the table. The objection seems to be to the fact that the banks earned ($13 billion by their estimate) on the money that was lent to them. That approach is a major shortcoming of the article. Earning money on the money they borrow (whether borrowed by taking deposits or pledging their assets) is what banks do.

In fact, Dodd-Frank, the Volker Rule, and a raft of other regulations dating back to the 1930’s attempt to force banks to rely on the very approach the article uses to measure mispricing (i.e., net interest margins). It’s almost as if the author objects to expansionary monetary policy. Usually expansionary monetary policy involves forcing down short-term rates thus steepening the yield curve and increasing net interest margins.

It seems the author has an implied assumption that the Fed should not take actions that allow the banks to profit. Seems more reasonable to assume that if the Fed can make a profit doing something that facilitates others making a profit, it has a better chance of success. People have an unfortunate tendency to let greed run amuck and thus pass up profitable opportunities simply because they can’t capture all the profit. The author seems to have fallen into that trap. Fortunately, the Fed is in the enviable position of being immunized against this particular form of financial folly by little things like the ability to print money. Lucky Fed.

So, the relevant question isn’t: How did the banks do? The relevant question is: How did the Fed do? As Bagehot pointed out a century or more ago, “During a financial crisis a central bank should lend freely against good collateral at usurious rates.” It will make a profit and end the liquidity crisis. That’s the relevant criteria.

Looked at from the proper perspective a few things about the article jump out. First, the author doesn’t seem to say how much the Fed made in profit. Guess he feels making a profit isn’t worth the effort unless it forces someone else to experience a loss. If one adds up the 190 loans shown on the table, the total profit to the Fed seems to be about $13 billion. One can’t back out a rate they charged directly from the article, but it looks to be about 1%. If correct, that’s, not a bad rate to earn on very short run (e.g., overnight) lending against collateral. It’s actually high.

If around $13 billion is the Fed’s profit, then the Fed’s profit is as great, or greater, than the profit the author thinks the banks made using the money. Since all but three of the 190 loans were profitable, all were short run, and all were collateralized (although in some cases the collateral was the equity of the bank as measured by its stocks price), the Fed wasn’t taking on the kind of risk the banks took to capitalize on the net interest margin.

One can’t fault the Fed on the “make a profit” front. Could it have been more? It’s clear such an assessment would be a lot easier now than it was then. At the time, some banks tried to say “no thanks” to the terms and experienced some arm twisting; Lehman had just failed to get liquidity at a price they would accept; Paulson’s terms for AIG got eased by the next administration for fear they would bust AIG, and even the media, which now seems to be having second thoughts, was calling for someone to “do something,” as one headline read. Yet, despite how much more we know now, it’s still questionable. “Higher rates” certainly weren’t the cry of the mob in 2008 and 2009.

So, the Fed made a profit and got reasonable rates on their loans. What about “good collateral? That’s where the article ought to be focusing. During a major panic when the need to get liquidity into the system could have swamped good judgment, the Fed made 190 loans that are listed in the article, and only three lost money.

Any way one looks at it (e.g., 1.6% default rate by number of loans, what looks to be $79M write-off on $7.7 trillion in loans, $79M of the $1.2 trillion managed portfolio of loans), there is NO room for complaining. In fact, given the severity of the crisis, it’s amazing more institution weren’t insolvent. It truly was a liquidity crisis. The figures, $1.2 trillion and 190 institutions, illustrate how severe it was. But, by highlighting the severity, the article would provide justification for a lot more mistakes than 3 in 190.

When Should the Loans Have Been Disclosed If At All.

The second issue is also awkwardly implied by the use of “secret” in the title. It’s hard to take this too seriously. Who the heck didn’t know the Fed was lending money? At the time there was open discussion of the fact that the Fed was using alternatives to the discount window in order to avoid the stigma and potential runs that might result from the disclosure associated with discount window operations.

Some of the stronger banks were encouraged to disclose their use of the facilities so that the stigma wouldn’t automatically be attached to other banks when it was disclosed that they used the facility. There were announcements of new lending programs regularly. (It seemed like a regular Monday event on Bloomberg and CNBC). There were allusions to dropping money from helicopters and blasting it out with bazookas. Funny kind of secret, to say the least.

By hyping conspiracy images of secret deals, Bloomberg may get coverage, but it hardly advances a serious discussion of when should this information be disclosed. To their credit, they do present the counter argument: “The Fed, headed by Chairman Ben S. Bernanke, argued that revealing borrower details would create a stigma.” Unfortunately, the article’s handling of the information only reinforces the impression Bernanke was right. That’s unfortunate because the information, if analyzed objectively, instead of with an eye to headlines, could add to a public understanding of the issue.

In defense of the article, nothing is as offensive as the reaction of the political class. I just wish the article had bothered to point out the lies in the “No Clue: Lawmakers knew none of this,” posturing of politician trying to ride the populist dislike of banks. How can the author let politicians say they didn’t know? Perhaps the lawmakers didn’t know the Fed lends money to banks? I don’t buy it: even if one doesn’t think politicians are the brightest light on the tree, they’re not that uninformed.

The author set up the evidence that lawmakers certainly knew with statements like: “The Fed has been lending money to banks through its so-called discount window since just after its founding in 1913. Starting in August 2007, when confidence in banks began to wane, it created a variety of ways to bolster the financial system with cash or easily traded securities. By the end of 2008, the central bank had established or expanded 11 lending facilities catering to banks, securities firms and corporations that couldn’t get short-term loans from their usual sources.” The politicians knew.


Keep in mind the statement about Bloomberg doing a public service by forcing the disclosure of the information. With that as a starting point, the open issue becomes when should it be made public? The Bloomberg article was a surprise in that respect. It seemed to indicate that not enough time has passed for there to be a serious analysis of the information. Perhaps the right amount of time is after some portion of a business cycle, or just not during election campaigns. Either conclusion would be unfortunate.

Seems to me congressional hearings on the appointment of the next head of the Fed or Bernanke’s reappointment would be when the information will be most needed. However, often a Fed chairman offers a new President his resignation, if Bernanke follows that practice, it’s relevant to the new President’s decision. Similarly, if the new President wants Bernanke’s resignation before the Fed Chairman’s term is out, the information may be useful as an explanation for the President’s request. It will then be up to Bernanke to decide whether to serve in a hostile environment, and whether to defend his method of ending the liquidity crisis.

Followers of this blog are aware that it has argued that the Fed may be overshooting on liquidity injections (see: “Stimulus Can Backfire: Monetary Policy,” “The Fed Cannot Force Investors to Shift to a Different Risk-Return Profile,” “Speak Softly But Carry a Big Stick, Dr. Bernanke,” and “Operation Twist, Or Is It the Logic That’s Twisted?” for discussion and details), but during 2008 and 2009 liquidity injections weren’t overshot. This article confirms that during that period the policy was carried out quickly and efficiently. If anything, the Fed’s subsequent potentially ill-considered revisits to liquidity injections may indicate that the initial efforts should have been bigger.

Those who follow this blog also know that when discussing TARP (See: “TARP: A success not being acknowledged”), the advice has been “follow the money.” To illustrate, one comment was “One has to follow the money and check the accounting on any pro forma. Obama and governments don't use Generally Accepted Accounting Practices (GAAP). It is essential to follow the actual money flows.” That’s the only a way to penetrate the posturing associated with the financial policies. By forcing disclosure, Bloomberg made it possible to actually follow the money. Unfortunately, they chose a different path, and by so doing, they made it harder to “follow the money.”