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A running argument between Alan Greenspan and Ben Bernanke, on one side, and a small band of vociferous critics, on the other side, turns on a question easier to pose than to answer: Did the Fed contribute to the credit binge and housing bubble by holding short-term rates too low too long in an effort to ward off deflation in the mid-2000s. Greenspan and Bernanke said: No, and they've got numbers to make their case. Now comes a pair of economists from the European Central Bank to make the opposite case.
In a working paper, Angela Maddaloni and Jose-Luis Peydro use data from U.S. and European surveys of bank lending officers to argue that low short-term interest rates led lenders to soften standards for loans to households and corporations. “The softening is even amplified when, at the same time, securitization activity is high, supervision for bank capital is weak, and monetary policy rates have been too low for too long, especially for mortgage loans,” they say.
But low long-term rates, they find, don't have that same unwelcome effect “somewhat in contrast with the hypotheses of many commentators who argued that the financial crisis was caused by an excessive risk-taking stemming from low levels of long-term interest rates, linked to current account imbalances.” That would be a jab at Bernanke, and his case that the global savings glut is more to blame than anything the Fed did.
“In the recent crisis,” they write, “the impact of low monetary policy rates may have been even greater given the concurrence of three elements: the strong reliance on short-term liabilities to leverage up, a weak supervision for bank capital and the high level of financial innovation, notably securitization.”
Central bankers, they advise, should “pay more attention to financial stability while banking supervision and regulation should take in account” macroeconomic effects.
Read a related Capital column on the risks of the Fed’s current policies.
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The Fed accumulated Treasuries in its SOMA between 2003 and 2006 expanding its balance sheet and thus the supply of reserves availableto banks. During the same time, the Cost of Fed Funds rate was steady first then rising. The Fed ignored this trend. The bank reserve system before interest on reserves was a DEMAND-ENABLED system where all the Fed had to do is to hold the cost of funds at or below its target disregarding M0, the monetary base. Yet banks carelessly accomodated the unsatiable demand for credit which drained banks’ ability to satisfy already vanishingly low reserve requirements necessitiating the Fed’s constant expansion through asset purchases.
The fact that the Fed asked congress to move up the authoriztion of interest of reserves before marked a clear sign that Fed Funds Targeting which began in the early 70’s had failed as a paradigm of monetary policy. With IOR, the Fed now has the power to unhinge with impunity the supply and the cost of Fed funds thinking that this can be done at no perril. Yet we already see the next bubble……Treasuries and Commodities whose prices have inflated. Banks are funneling Billions of Dollars in excess reserves into these two markets inflating their prices.
The Fed has failed again. It did so while restrained under the gold standard, after the gold standard, and after the treasury standard. The Fed and elastic money are the two most pressing obstacles standing between this nation and long-term prosperity.
I remember the “good old days” when there was about 5% “sttructural” inflation, when banks paid about 5% annual interest on savings accounts, when credit cards were less prevalent and wallets fit in back pockets, when house values increased by about 5% each year, and when folks felt better because they could see their savings grow and the values of their core assets grow reliably.
Life at 0-0.1% inflation sucks.
Seniors looking for “some” or “any” growth in savings to help them adjust to life after retirement are now confronted with the requirement that they must risk a lot to get a pittance in interest.
The margin for error, the resilience of the financial system, the personal resilience of those looking to build or retain a nest egg - all seem to be in much more jeopardy now then “way back when.”
But, the ability of corporations and banks to make profits in a zero-interest borrowing environment remains fairly good. And those able to accept large risks with large investments have access to payoffs that those without that ability cannot aspire to.
This is not a lot of comfort to those much nearer the bottom rungs of the economic ladder.
My goodness, stop blaming The Fed for everything that happen in the economy.
Enriching the Elite, disseminating propahanda that a richer rich, weaker dollar, high living cost is good for the economy (their economy) and a willing middle and working class to lap it all up while they remain politically distracted with the Repubs vs. Dems rivalry all plays into the “whatever it takes” theme professed by the Fed to keep ripping them off and getting them to love being fleeced.
It is very difficult to determine who is more incompetent; the dc stooges or the fed.
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