Quote of the Day

[T]he Federal Reserve System has recapitalized major U.S. banks by paying interest on bank reserves and by keeping an unusually high interest rate spread, which allows banks to borrow short from Treasury at near-zero rates and invest in other higher-yielding assets and earn back lots of money rather quickly. In essence, we’re allowing banks to earn their way back by arbitraging interest rate spreads against the U.S. government. This is rarely called a bailout and it doesn’t count as a normal budget item, but it is a bailout nonetheless. This type of implicit bailout brings high social costs by slowing down economic recovery (the interest rate spreads require tight monetary policy) and by redistributing income from the Treasury to the major banks.

Tyler Cowen, The Inequality that Matters

(He ends with a very disappointing, hands-thrown-up-in-the-air conclusion. I do not believe we are as bereft of policy options as he suggests. Possibly more on this later from me.)


NRO: One thing that matters to you and a lot of disciples of Austrian economics is inflation. Some think it’s necessary and good because, with sticky prices, it helps to stimulate growth. Can you explain your problems with steady inflation?
PAUL: It’s the worst thing any government could deliberately do. It’s counterfeit. It means some people will benefit at the expense of others. People who saved money and are living off their savings get cheated. It’s a moral issue: They might make 1 percent on their certificates of deposit, and they can’t live on that. And the government practically gives the money to the banks and then they turn it over and buy Treasury bills and bonds and make 3 or 4 percent. So they make billions of dollars after having just been rescued from their bankruptcy.

Ron Paul, interviewed in NRO.

18 thoughts on “Quote of the Day”

  1. Tyler Cowen is too gentle in his criticism; Ron Paul is closer to the mark. It isn’t so much a bailout of banks or a case of the govt “giving money” to banks as it is a straightforward transfer of wealth, a looting of the accounts of ordinary taxpayers to pay off politically-connected big businesses.

  2. Righto, Jonathan.

    Most people don’t even know it is going on.

    Cowen acts like it is the order of nature, and cannot be stopped.

    Still, the article is good on description, even if it falls short on prescription.

    Paul wants to at least smoke this evil into the open.

    There is no reason the American people should be tolerating this.

    This is really the big test for the GOP.

    If they are unwilling to touch this, they should be gotten rid of.

    If the Tea Party people don’t go after this, they have failed.

  3. The media don’t deal with it either, preferring to misframe the issue as “bankers’ pay”.

    It is a tremendous scandal.

    Another scandal is the Fed’s eagerness to support a political agenda that is diametrically opposed to its mission of maintaining monetary stability.

  4. One of the most depressing things I see these days is the extent to which businesses in all kinds of industries have their rent-seeking paws out for taxpayer money. See the link in this post to the report by a pack of weasels including Eric Schmidt and Craig Mundie.

    Note the crack about “Republican anti-science bias” in what is supposedly a business/tech website.

  5. Most established businesses try to lock in their position by obtaining some legal or regulatory advantage.

    But let’s face it, the big banks make everyone else look like dunces by comparison. They have the U.S. Government shoveling money into their hands in ten figure increments. Very nice work if you can get it. Plus, if something goes wrong, the taxpayer bails them out. Extremely nice work if you can get it.

    These guys are ransacking the country, and very few people say a word about it.

    As someone said, life is unfair, Big Labor has one political party, but Wall Street has two political parties.

    On this issue O = W.

  6. I’m increasingly leaning to a counter-intutuive description of what is going on. I don’t think this is a case of evil bankers looting the public treasury, I think the real problem here is that the government massviely effed the financial system d by pushing the residential mortgages bubble but now they want the banks to act like there is no problem and lend like its still a boom time.

    The reason that both the Republicans and the Democrats are following the same basic policy is that right now, the government needs the banks more than the banks need the government. Even now, the financial industry has almost all of the capital needed to reboot the economy. The smart thing for a bank to do in uncertain times is to make conservative use of their depositor’s money. However, the government wants to banks to lend to all and sundry largely regardless of risk.

    The real problem here is that we just don’t want to eat our losses on the whole housing bubble. Everybody in the government is running around trying to pretend we didn’t destroy vast amounts of wealth. They’re trying to get all banks to behave as if they were legitimately solvent when many of them simply aren’t. The government wants to banks to make more risky loans. The government wants the banks to operate against their own long-term self-interest for the supposed common good (and to save the government’s hindquarters.) The only way the government can make the banks take risk is to bribe them with public money.

    The profits that banks make represent just a tiny fraction of the capital they move through the financial system. The government is hoping that by giving the banks that tiny fraction of profit, they can move vast amounts of capital.

  7. I think there may be a cultural problem with the banks, in that many of them have focused on (a)residential lending based on standardized and mostly-automated credit criteria, and (b)extending credit in big chunks to large enterprises. It is not clear how many of them still have the human resources in place, in the form of experienced loan officers who are given appropriate discretionary authority, to satisfy the credit needs of medium-sized and smaller businesses. This is particularly true at a time like now, when it’s fairly easy to just make money off the spread between depositor rates and the 10-year Treasury, or for that matter between short and long government rates.

    There is a very interesting class of companies called Business Development Companies which are not banks but do medium-sized company lending, sometimes but not always including an equity stake (I’m a shareholder in a few of these) and there are also some Limited Partnerships focused on this kind of lending….but their resources are a drop in the bucket compared with the needs.

    I have the feeling that this entire sector of the economy may be ripe for some changes.

  8. Clearly the government has played favorites and helped some folks that should be out of a job and/or out of a business, and allowing the country to adjust to a changed reality. It is kicking the can down the road that will eventually lead to further economic disruption. It is worse than that though because, in providing funds without allowing the failures to happen, the favored monied end up in competition with private un-favored-by-the-government investors, savers, and spenders for all sorts of investments and products. Those who haven’t received the favored monies who are forced to pay more for less.

  9. Lexington Green,

    I’ve read the Cowan article but I don’t think it really undermines my argument, in fact, I think it supports it.

    I am arguing that the government is trying to use banks to reach political goals e.g. increasing home ownership, stimulating the economy etc. To accomplish this, they “create incentives” (bribe) the banks to engage in some behavior the market will not otherwise support. In other words, in order to get banks to engage in a non-market supported behavior, the government must do something that leaves the banks better off than the bank would be without the government intervention.

    (I suppose this only applies to what we might call “positive” actions by businesses such as making more instead of fewer loans. If the government wants a “negative” actions, making fewer loans, the government can just ban the loans by fiat. )

    When the goal was increasing homeownership rates beyond those supported by the free-market, the government had to use Freddie Mac, Fannie Mae, FHA, VHA etc to make the non-market loans more profitable for banks. The end result was that banks made more money than they would have without the intervention.

    When it came to bailing the banks out, the government had a goal unsupported by the markets i.e. keeping failed banks legally solvent and still lending. Again, they ended up creating favorable circumstances so that the banks would end up making more money.

    It’s not just banks. If the government wants any business, large or small, to engage in some non-market supported behavior, they have to leave that business better off for engaging in the behavior. The government has to do it that way because that is the only way to sustain the behavior long term. If they made mortgage lending less profitable, eventually, the banks would fail. If the government wants a business to hire more people than the market supports, they will have to make hiring more profitable or the business will fail. If they want a business to locate in a certain area, they have to make that more profitable than not doing so or the business will fail.

    At first glance, this looks like the businesses manipulating the government to make more money but it’s really the government paying the businesses to accomplish the political goal.

    I think we’ve grown so accustomed to the government blocking “negative” behaviors that lower profits that we’re ignoring the government actions that raise profits.

    It goes back to there-a’int-no-such-thing-as-a-free-lunch. Somebody has to pay for every economic behavior. When the government wants businesses to engage in a non-market supported behavior, somebody has to pay for the cost of that behavior because the market isn’t going to. No matter how complex the means of routing money to the business maybe, in the end, someone other than the business must pay.

    The business always comes out ahead.

    The only way to prevent this is to not try and use businesses to accomplish political goals unsupported by the market.

  10. Shannon:

    “The business always comes out ahead.”

    Yeah. Regulatory capture is the whole problem. And it is inevitable when you have a large and intrusive regulatory state. The only regulation that really works is marked discipline, and that is the one thing every business is desperate to avoid.

    ” I don’t think this is a case of evil bankers looting the public treasury … .”

    I do.

    They choose to do what they do, and they have built the system to their advantage, at ruinous cost to everyone else, as the facts in the Cowen article demonstrate.

    This matters because we as conservatives and libertarians are very prone to see “the government” as the problem, which it is. But that is a very incomplete analysis. We have a tendency to think of government vs. business = good and freedom vs. bad and despotism. But that misses too much of what is going on. The government acts at the behest of the people it is supposedly regulating, to their advantage, and that is the biggest problem. Mancur Olson wrote about this, George Stigler wrote about this, yet it is too little understood by most people. It is a corporatist / fascist union of business with government power which is our biggest problem. In Illinois it is called the Combine, and it controls both parties. In DC there is more autonomy on the GOP side but not much more.

    Other than amount of culpability we attribute to the bankers who are making a kings ransom out of this Depression, which changes the way we describe the problem, it appears we agree about the mechanics of what is going on here.

  11. Lexington Green,

    I don’t think this is really a case of regulatory capture because the primary cause isn’t the governments attempt to regulate the banking industry. Regulation is the government trying to stop a business from doing something that the business wants to do. The dynamic here is that the government is trying to get the businesses to do something that the government wants them to do.

    They choose to do what they do…

    Well, actually they don’t. Subsidizing residential mortgages wasn’t a banking industry idea. In fact, many opposed it initially because it came with so much regulation. Neither could banks refuse the bailout as has been amply documented.

    …they have built the system to their advantage…

    I would argue that is “we” through the agency of the government that built the system to the advantage of the banks. Why? Because we wanted banks to lend more money for home ownership. To get banks to lend more for mortgages, we rigged the system so that they could make a lot of money doing just that.

    We paid the banks to make more risky loans. Why are they moral at fault for doing what virtually everyone, except a few libertarians, wanted to pay them to do?

    Cowan’s article demonstrates HOW the banks have been advantaged in last three decades but it doesn’t explain WHY those advantages came about. I think we default to the assumption that if the government does something to someone’s advantage then that someone must have manipulated the system to get that advantage to the detriment of everyone else. That might be true in many cases but it quite clear in this case that we all collectively decided to use banks to accomplish a non-market goal and we decided to bribe the banks to implement those goals.

    Likewise, the bailout was not the result of banks unjustly manipulating the government but rather the government not wanting to deal with the political consequences of widespread bank failures. Right now, the market is signaling it is a bad time to loan money but we want the banks to loan money against the market signal so we are bribing them to do so.

    Of course, the banking industry has input into all the decisions but they don’t control them. Think of it this way. Suppose we had successfully implemented a law to prevent banks from having any political input whatsoever. They couldn’t donate to any political cause, they had no input on regulation or legislation.

    Now, in your model of the current problem, this should have prevented all these problems from coming about because the banks wouldn’t have been able to rig the game in their favor.

    In my model of the current problem, this would have had little effect because the government and voters would have still set up all the government programs to induce banks to lend. The missing input from banks wouldn’t have had much effect as long as everyone else was hell bent on encouraging homeownership. The bailout would have happened in much the same way because the primary driver was the government trying to prevent a general collapse. What the banks wanted didn’t matter much. The current actions would still take place because the government wants economic growth at all cost.

    It’s just like if we want farmers to grow more or less food than the market supports. Either way, we would end up paying farmers more for altering their behavior than they would have made if they did not. It wouldn’t matter what the farmer did or did not want or how much input they had on the decision.

  12. Shannon, we disagree on the impetus for all this.

    “Of course, the banking industry has input into all the decisions but they don’t control them.”

    First, generically, it is always a matter of incentives and who is motivated to act. The regulated industries have the interest, the intelligence, the expert knowledge, the ability to take the long view. The top personnel are a revolving door. They drive it. The government’s initiatives are spasmodic and inconsistent and don’t last long. The “government” barely exists as an acting, thinking agent by comparison.

    My personal observation and anecdotal knowledge of actual lobbyists and regulatory lawyers is consistent with this.

    Further, as an interesting aside, the very good older book The Liberal-Democratic Mind in the Age of Gladstone by Robert Kelley sheds an amazing light on this subject. Kelley shows that three big influences on the 19th Century liberal thinkers were Adam Smith, Thomas Jefferson and Edmund Burke. However, the old-school liberals in Britain, the USA and Canada saw these thinkers differently from the way we do. To the people of that age, the biggest threat to liberty was not the state itself. To them, the biggest threat was private interest capturing state power, especially in the form of monopolies or state favors to private business. This is the Smith of anti-mercantilism more than the Smith of laissez faire, the Burke who opposed the connected interests around King George not the Burke of the Reflections, the Jefferson as anti-Hamiltonian more than the Jefferson of the Declaration. In other words, the Founders and their heirs for a century were afraid of exactly what we have now to a degree that is too little appreciated. They also believe that business would always and everywhere seize the state for its own profit any time it could, which is pretty much correct.

    So we disagree with who initiates this more often. I see incentives, what I have seen myself, my understanding of current practice, and the historical roots of this problem, all pointing to business not government as the prime mover in increasing the power and scope and cost and abusiveness of the regulatory state, for its own advantage and profit.

    As far as policy goes, I don’t think there is any daylight between us. Dismantle the regulatory state, root and branch, amputations not pedicures. The problem is that the people who benefit from it have a strong incentive to preserver and protect it, and the people who suffer from it have diffused harm and other things they need to do for their day jobs.

    It will take a mass movement and some emotion involved to get people motivated enough to get anything done on the issue.

    If that does not happen, the current reform wave will be captured and coopted and the game will go on.

    Sadly, that is the most likely scenario. But I am enough of a romantic to think that it is not inevitable.

  13. ” am arguing that the government is trying to use banks to reach political goals e.g. increasing home ownership, stimulating the economy etc. To accomplish this, they “create incentives” (bribe) the banks to engage in some behavior the market will not otherwise support. In other words, in order to get banks to engage in a non-market supported behavior, the government must do something that leaves the banks better off than the bank would be without the government intervention.”

    While this is a logical argument by Shannon that assumes good intentions on the part of the policy makers, I am not seeing any empirical evidence that this is the case. Or that American banks, say, investing in foreign securities is likely to lead to an increase in economic activity of any kind in the United States, much less increased loans to prospective home owners, small businessmen or others with collateral and good credit who are currently finding securing a bank loan to be a) difficult and b) expensive.

    There is no quid pro quo here. Banks, including foreign banks, are taking almost free money from the Fed and investing it and pocketing the difference. If the liquidity is not needed to stabilize a bank in trouble or to be used for extending credit, then it amounts to a gift to connected people. The Fed might as well give the money to me then – I’d at least spend it here and invest in business enterprises and that would do more systemic good rather than locking it up in foreign bonds.

    If the Federal government wished to stimulate home ownership they have many fiscal and statutory levers to do so other than indirectly prodding banks in this fashion, but they are not doing so. What this crew of oligarchical ass****s are discussing in think tanks is terminating the home mortgage deduction for the middle-class.




  14. “Of course, the banking industry has input into all the decisions but they don’t control them.”

    I’ve always imagined that, beyond any “carrots and stick” the administration(s) may have had, that a banker, looking over at Freddie and Fannie had to ask himself “do I want to continue to be a banker who makes mortgage loans?”….or even “do I want to continue being a banker?” and the answer was “of course I do, so I’d better get on the stick and do what the competition is doing”.

  15. “Tyouth, take a look at Bailout Nation. Things are so bad your stomach will hurt.”

    Yeah I should read it. I used to check on Ridholtz’s blog from time to time but have stopped since I had comment censored there which expressed the opinion that federal agency was largely responsible for the meltdown (along the lines of the comment I made above this one here). Apparently he disagrees and had heard the argument too many times. It’s his blog so he can censor what he wants to, I suppose.

  16. Never read his blog. The book is good.

    You may have had a comment deleted because he was in a bad mood or something.

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