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The · Psychohistorian


Paying banks not to lend

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Bernanke and various monetary "doves" on the federal reserve are talking about more asset purchases - pushing money into the system by buying up treasury bonds, mortgage securities, and other debt. Before the fed acts on this, they really ought to take a look at where their previous trillion dollars plus of asset purchases went. Here's a graph of excess reserves - basically, the amount of reserves that the banks don't lend out:



As you can see, the quantitative easing so far has gone directly into excess reserves - it's just sitting there, doing nothing, and not being used to make loans that could help the economy recover.

Why aren't the banks lending the money out? Well, at the same time that the fed did the first round of quantitative easing, they also started paying interest on reserves, including excess reserves. It's only about a quarter percent, which doesn't sound high, but with mortgage interest rates running at 4% compared to mortgage default rates in the range of 10%, any positive interest rate doesn't sound so bad. Basically the banks can sit on the cash and make some money perfectly safely, without having to worry about making loans that might go bad.

There's no evidence that the first round of quantitative easing has done anything to help an economic recovery. Before doing more of the same and hoping for different results, maybe the fed needs to cut back or eliminate that risk free interest that they're giving the banks.

Of course, that would mean Bernanke would be making his friends in the New York banks do their jobs and figure out how to make loans to people likely to repay them while avoiding loans to people who are likely to default. Why do that, when he can dump more money into the system and keep his banking pals on the government dole, instead.

Announcement of payment of interest on reserves:
http://www.federalreserve.gov/newsevents/press/monetary/20081006a.htm
Bernanke supports more asset purchases:
http://online.wsj.com/article/SB10001424052748704779704575553813746866210.html?mod=WSJ_economy_LEADStoryTop
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