Tags: Wray | Fed | Minsky | crisis

Report Reveals Fed Support for Banks — Part I

By    |   Thursday, 02 May 2013 02:41 PM

At the 22nd Annual Hyman P. Minsky Conference on the State of the US and World Economies at the Levy Institute in New York, L. Randall Wray, an economics professor at the University of Missouri – Kansas City, presented a paper, which was funded by the Ford Foundation, titled "Report of a Research Project on Improving Governance of the Government Safety Net in Financial Crisis."

This continues to be a timely subject, as central banks announced further support for the global economy and financial and housing stocks continue to soar, indicating that the authorities may have succeeded in re-inflating the financial bubble of the mid-2000s.

An introduction to Minsky for conservatives: Hyman Minsky (1919-1996) was a liberal economist who served as consultant to a project called the Commission on Money and Credit that was conducted from 1957 to 1961 for the purpose of studying what should be the role of the Federal Reserve, updating the work of the Aldrich Commission of 1908 to 1911, which led to the creation of the Fed roughly 50 years earlier to help it quell recurrent financial panics.

Minsky believed that financial markets are inherently unstable. The moment when the market succumbs to pent up pressures and collapses has come to be known as a "Minsky Moment." The appropriate response to such events is assumed to be government intervention. It is therefore no surprise that while the Minsky conferences have been held for 22 years, the events of 2008 generated renewed interest in Minsky, and the plethora and extent of the interventions, multiplying and continuing to this day, suggest that Minsky would have thrived and prospered in the current environment.

Wray listed factors that caused the collapse of 2008, including a phenomenon he called "money manager capitalism," based on "financialization" of the market, layering of risks and a dependence on liquidity. The market would be subject to collapse whenever liquidity would become unavailable. From Wray's perspective, New Deal reforms, such as the Glass-Steagall Act's separation of commercial and investment banking, had been shredded. Investors came to believe that former Federal Reserve Chairman Alan Greenspan's "Great Moderation" represented a real and lasting change in the way markets work.

The response to the crisis began with then-Fed Chairman Hank Paulson's infusion of $800 billion to banks that Wray labeled "Don't ask, don't tell," as the Treasury proposed to purchase toxic assets but ended up injecting capital into shaky "too big to fail" institutions that the authorities insisted were healthy and didn't want the money. This was coupled with an $800 billion fiscal stimulus program that Wray criticized as "too little, too late. The Fed undertook unprecedented subsidized lending and asset purchases in support of the Treasury program in what Wray called an effort to "prop up Money Manager Capitalism."

Wray presented a chart that showed a spike in intervention by global central banks in the fall of 2008, except for the Bank of Japan, which has joined the party recently, and another chart that documented the rise of the Fed's balance sheet from about $750 billion to four times that size. He noted that 80 percent of the support went to just 13 too big to fail financial institutions, and that the largest banks are subsidized to the extent of $83 billion per year to play the spread between practically free money and Treasury securities, with the five largest getting more than three quarters of the total. JPMorgan Chase borrowed virtually free money from the Fed 144 times.

Specific outrages were: 1) Bank of America borrowing $260 billion at 0.45 percent from the Term Auction Facility; 2) Morgan Stanley ($50 million) and Goldman Sachs ($200 million) borrowed at 0.01 percent from the Single-Tranche open market operations; and 3) Citigroup, Merrill Lynch and Morgan Stanley combined borrowed $6 trillion at 1.06 percent, with Citigroup cumulatively borrowing $2 trillion at 0.88 percent.

Bankers often claim that a crisis episode is one of "liquidity, not solvency," conveniently ignoring the link between the two concepts. Wray took this issue on directly, beginning with a quote from Walter Bagehot that a central bank should lend without limit, against good collateral, at a penalty rate.

Wray observed that banks have come to rely on extremely short-term finance, of questionable assets. When creditors lose confidence and refuse to roll the credits over, a liquidity crisis can become one of solvency. The Fed alleviated this pressure through a series of "alphabet soup" lending facilities and then through seemingly permanent quantitative easing.

The authorities acted to dispel a stigma attached to using the discount window during the crisis by invoking a provision that allowed banks to be saved upon a finding of "exigent and extraordinary circumstances."

During the Q&A part of the presentation, another panelist, Walker Todd, long-time counsel to the Federal Reserve Bank of Cleveland, seemed to agree that aid was supposed to be provided to save the financial system as a whole, not a particular institution, and once the crisis passed, troubled institutions were supposed to be put through a process of resolution.

This concludes the first part of the article. Part II will discuss the rest of Wray's analysis, including proposals for reform.

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At the 22nd Annual Hyman P. Minsky Conference, L. Randall Wray, an economics professor at the University of Missouri – Kansas City, presented a paper titled "Report of a Research Project on Improving Governance of the Government Safety Net in Financial Crisis."
Thursday, 02 May 2013 02:41 PM
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