TARP
(Link, in case the video above does not play)
In the video above, the Daily Show slams the Fed for giving banks $7.7 trillion in secret. This is a gross misrepresentation that started with a shoddy Bloomberg story and was later echoed elsewhere in the Blogosphere.
Simply put, the Fed did not lend anywhere near $7.7 trillion. It was closer to $2 Trillion. Secondly, this total was widely publicized at the time. (What was kept secret was the details about which banks got funds and how much. Everyone knew the details were not being disclosed, and some politicians were quite vocal asking for the details.) The Fed responded to Bloomberg's article, and Bloomberg says they "stand by their reporting", but the details of their clarification show that they were at least guilty of writing in a way that readers might easily be misled.
As much as I would like to see the Fed wound down, this sensationalist approach is not the way to tackle the issue.
TARP was mostly good: Here's the most important thing: given our context, in general terms, the Fed did the right thing when they provided lots of liquidity to the banks. Let me explain...
Since 1913, the Fed has been the lender of last resort. When the banking system is hit by a run, a lender of last resort provides liquidity against good assets (which cannot be readily converted to cash). Without this, the run can actually bring down banks that are solvent and sound in the long-term, but not liquid. The collapse of a banking system is not a pretty sight. Someone who wants extreme pain, confusion and suffering -- perhaps under the delusion that a better system would be born from the ashes -- might think a widespread bank run is a good thing. Anyone who thinks collapse is bad, would not want a bank run. Under our current system, the Fed is the only institution that can prevent a run.
Collapse is not the path to the ideal: Yes, if we had a good banking system, the Fed would not be a lender of last resort, because we would not have a Fed. If the Fed is to be closed down, if fractional banking is to be reduced or modified, if the FDIC is to stop insuring deposits, then these must be done thoughtfully. It makes no sense to pull away all the scaffolding that has been erected over decades and simply walk away. Having all those structures in place, it makes no sense to say that the Fed should not act as a lender of last resort.
TARP has enough bad aspects: The legitimate criticism of bail-outs ought to focus on questions like this:
- did the Fed provide funds to institutions that were actually insolvent (not just ill-liquid)?
- did the Fed extend cover to non-banks that were ill-liquid, and to what extent was that legitimate?
- what role did political -- as opposed to economic -- considerations play a role in deciding whom to bail out?
Focusing on the actual provision of liquidity is pointless. That's the good part -- given our context.
(Aside: Daily Show cognitive confusion: The video above is quite typical of the Daily Show's critiques.Their pretense at being partly a comedy-show means that they can shrug off hyperbole and do shoddy fact-checking. This is unfortunate because their pretense at being partly a news show means viewers think that much of what they say is true. Is it a surprise that people who listen to the Daily Show think the system is ripping them off and that "Occupy Wall Street" is a worthy cause? )
I now wonder which people who criticized the Fed’s actions you had in mind. I began by thinking that you were referring to conservatives or the man in the street, but now it would seem to be Yaron Brook. If you are going to evaluate their criticism, you need to also address their underlying reasons. When you said, “Let me explain.” I was read for a considerable discussion, but it didn’t happen. It is what you need to offer.
ReplyDeleteLet me make just two points. One, the problem that we faced in the meltdown was that the Fed had been providing whooping amounts of “liquidity”, i.e., made-up money, to the economy for several years. The solution that Ben Bernanke offered and you are defending is for the Fed to pump in more “liquidity”, i.e., made-up money. The term, “lender of last resort” is an euphemism for some government agency that can create money ex-nihilo. Bernanke is like the quack medicine man who says that the best cure for poisoning is more poison.
The other point is that when this “liquidity” flows into the economy, the consequence is that assets, i.e., the capital that has been saved for creating new production, is at least partially channeled to the control of the people with the made-up money, instead of the control of the savors. This is called misallocation because the additional money makes it look like there is more saved than there actually is and part of the real capital ends up in less productive uses (or is consumed instead of invested). These misallocations have to be liquidated before the economy can get back on a rational course. That often means bankruptcy, even for people who did not realize that they had been taken by non-existent, made-up stuff. Putting more made-up money into the system, which is what TARP is about, just exacerbates an already bad situation.
It is true that we just don’t want to walk away from the banking system, but the winding down begins with stopping the Fed from making any more money, taking away its “lender of last resort” powers. It is true that collapse isn’t a good thing, but it is the natural consequence of what the Fed has been doing, and by letting the Fed do more of it we have only extended into the future the day that some kind of collapse will happen and made the collapse worse. The actual sector of the economy that leads the collapse may not be the banks but the brokerage houses, or the insurance industry may be the victim. It will happen.
The exact same thing is happening in Europe right now. Nearly everyone but the Germans are shouting for the European Central Bank to create money and buy worthless government bonds from Greece, Italy, and Spain, i.e., put in more liquidity in a very big way. Everyone knows that those countries’ governments will not be able to pay back their debt, so they want the ECB to create more money and ultimately destroy the value of the euro so that the governments can pay it back in nearly worthless currency. That is the same thing as a collapse and it will not be any more fun. At least a banking collapse in 2008 would have been a short collapse and recovery could start soon. The problems in Europe, and here, will drag on for years.
C.W.
ReplyDeleteThanks for the comment.
I really wasn't thinking of anyone specifically, but I know that at the time of TARP a lot of my friends were against it without quite understanding it all. I didn't realize Brooks was against it, and would not assume so without reading what he specifically had to say about it. Actually, some of the immediate people I had in mind were certain libertarian Fed critics who were taking the recent Bloomberg article as more proof that TARP was bad.
Of course there is a lot to criticize about TARP. And of course TARP should never have been done in the sense that if we had proper banking system we wouldn't have a Fed in the first place. However, in the context we found ourselves in, it was extremely important for the Fed to provide liquidity (and also guarantees).
I do agree with your criticism that I didn't flesh out my argument enough. So, look out for a follow-up post.
Yaron Brook discusses the bail-outs and lots of other things on The Front Page with Allen Barton once or twice a week. I do not have a spicific video to send you to, but if you look at the titles, you can probably find one. He says that the banks should have failed and the TARP did nothing good. (general: http://www.pjtv.com/?cmd=mpg&mpid=113).
ReplyDeleteI do not understand you reasoning. Somehow, when this "context" it is okay, even necessary, to do what would be a very bad idea in capitalism, right? The problem is that the laws of economics, how things work out in the real world, do not change even if the government passes a law or a thousand. The consequences are the same.
C.W., the best analogy I can give is of a public school that is deciding whether or not to use a phonetic approach to learning words/spelling.
ReplyDeleteThe right answer is: we should not public schools.
However, in the context of public schools, the right answer is that it should use phonetics.
In pre-FED crises (1907), bankers like J.P.Morgan would step in and help banks that were subject to runs. However, they would make a distinction between banks that were solvent and ill-liquid as against banks that were insolvent or border-line solvent.
Under fractional-reserve banking, the way one stops a run is to figure out which banks are solvent and then support them by providing them with unlimited liquidity, while charging them what would be a penalty rate in normal times, for doing so. Without this, one risks contagion to extremely solvent banks.
One can argue against the fractional reserve system and against the Fed. I'd change the former and abolish the latter. However, that is not something one can achieve abruptly.
So, the best short-term approach is to ask "what would Morgan do?"
Part of what was done under TARP was classic provision of liquidity to solvent institutions. This was appropriate.
However, part of what was done was to provide solvency to insolvent actors and to not charge a penalty rate. This was the bad part.