The Fed’s big bank protection and profiteering racket is about to backfire on the economy and America.
Here’s how the Fed runs its rotten racket, how it surreptitiously served up massive profits to its big bank constituents after the financial crisis, what hole its dug for itself in the process, and how the new monetary regime it engineered is going to backfire on it, on America, and on you.
And, I reveal here how you can get even and make money on what’s going to happen next.
It’s not important to this muckraking story that the Fed caused the financial crisis by keeping interest rates too low for too long.
And that it allowed insanely leveraged banks it regulates to drive themselves and America to the brink of financial Armageddon in 2008, though it is important.
How Dirty Rotten Things Can Still Get in the Short Term
In the short run the Fed did what it had to do in order to save its banks and the financial system.
Those efforts included opening the Fed’s “Discount Window” to any bank that needed cash, making direct liquidity injections, buying underwater assets from institutions and parking them off banks’ balance sheets, organizing a Treasury bailout, and other extraordinary measures.
But the Fed’s TBTF banks still ended up broken.
While they should have been broken up, instead the Fed came up with an incredible long-term plan to return them to profitability, so they could grow even larger and more profitable in time.
The racket is remarkably simple and equally elegant in its naked brazenness.
None of the big banks, or any banks for that matter, were borrowing from each other in the overnight fed funds market during and right after the financial crisis. That’s because the banks knew all counterparty banks in any repurchase (repo) agreements were technically insolvent and no one wanted to lend to another technically insolvent bank.
Besides, banks didn’t need the kind of short-term money they borrow in the fed funds market to make commercial loans, or mortgage loans, or any kind of loans, because they weren’t making loans, period.
The fed funds market essentially stopped.
But government debt issuance didn’t stop and that’s what the Fed used to prop up its banks.
When the Treasury issues debt it’s the Fed’s primary dealers that usually buy big chunks of it.
But they weren’t able to buy the massive amounts of debt the Treasury needed to float. Nor were the banks that aren’t primary dealers, but buy Treasuries as part of their reserve requirements.
So, the Fed arranged to buy whatever the government was going to issue that any of its big banks would first step up and buy directly at auction.
In effect the Fed, instead of being “the buyer of last resort”, became the buyer of first resort of the nation’s debt.
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Banks bought as much government debt as they could, including in the secondary market, and flipped it to the Fed at a small profit, but a profit, nonetheless.
The Fed planned on buying so much Treasury debt from its bank constituents that it needed a new classification for its buying binge, which constituted a change in monetary policy.
That’s how we got QE, or Quantitative Easing.
QE is nothing more than the Fed buying massive amounts of Treasuries from banks and parking those “assets” on their make-believe balance sheet.
The beauty of the scheme is that banks, after the Fed pays them in cash (electronic credits actually) for the Treasuries they buy from them, park all that cash back at the Fed in order to get paid interest on their deposits. The interest banks get paid on their excess reserve deposits comes from the interest that the U.S. Treasury pays the Fed on Treasuries on the Fed’s balance sheet, which they bought from their banks.
How simple, elegant and brazen is that? It’s also what I call a complete racket.
The Fed Manipulates $1.5 Trillion 100%-Risk Free at Your Expense
Some of the details of how much cash banks have parked at the Fed and how much they’ve made off the scheme is in my previous article. You might want to re-read it here to understand how big this racket is.
Meet the new monetary policy, not the same as the old monetary policy.
The problem now is that the new monetary policy regime engineered by the Fed to save and enrich its big bank constituents is backfiring.
Banks have parked hundreds upon hundreds of billions of dollars of their excess reserves at the Fed in order to collect interest.
Collectively, they now have more than $1.5 trillion in excess reserves parked at the Fed.
Excess reserves are reserves above the level of “required reserves” banks must maintain and are an indication of how much money banks have to loan out but are hoarding.
The interest on excess reserves, known as IOER, is 1.8%. That’s 1.8% interest, not on long term deposits mind you, that the Fed pays on overnight deposits. And, it’s 100% risk-free.
What happened to repos two weeks ago, when banks needed cash to cover commercial deposit outflows as companies paid their quarterly taxes, and banks that bought Treasuries at the previous week’s auction and had to pay for them on settlement day, was a scramble for cash.
So much cash was needed that desperate banks had to pay as much as 9% for short-term repo loans in the fed funds market.
Since the Fed had just dropped the fed funds rate band to 1.75% – 2.00%, the most that any bank should have had to pay in the fed funds market, where repos are arranged, would have been 2%.
Proof of what’s backfiring with the Fed’s new monetary policy regime of stockpiling Treasuries to pay banks interest is banks don’t have enough cash to conduct normal activities.
When the Fed started to “unwind” its balance sheet, meaning it was going to let the inventory on its balance sheet “runoff,” as bills, notes, and bonds matured, and not replace them by buying equivalent amounts of replacement bonds, banks and formerly regular buyers of new issue Treasury debt had to step back in.
They bought Treasuries knowing the Fed would no longer subsequently take them off their hands by paying them cash so they could deposit that cash back at the Fed and collect risk free interest.
In other words, the Treasury is now prone to a “buyer’s strike” because of the Fed’s policy regime.
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That makes the Fed buyer of first resort of the nation’s debt.
And, because banks are hoarding cash at the Fed, they don’t have excess reserves on hand to lend to other banks through repos. That’s why repo rates soared.
The Fed recognizes the problems that it created and must now conduct daily repos with banks to keep the fed funds market running and keep a lid on the fed funds rate that it’s supposed to be able to control.
While the Fed has said that they may have to set up a Standing Repo Facility (SRF) to provide direct Fed repo money to needy banks and to maintain control of the fed funds rate, they’re not telling the American public the whole story.
An SRF won’t be enough to control banks’ funding problems, won’t be enough to facilitate banks’ buying Treasuries the government issues, and won’t instill any confidence in what the Fed’s created.
The truth is the Fed’s going to have to run QE programs, maybe indefinitely.
That’s a horrible monetary policy regime.
It’s the byproduct of the Fed’s pandering to its bank constituents to protect and enrich them.
The new monetary regime is so insane it makes MMT (Modern Monetary Theory) actually look doable, which of course it isn’t.
But if the Fed can permanently fund the Nation’s growing deficits and debt, why can’t it, under MMT, underwrite more debt for free tuition, free healthcare, or free money for people who don’t want to work?
Do you see where this is going?
Next week I’ll make it short and sweet for you and tell you what to buy and sell to make money from where the Fed’s racket is going to eventually drive us, which is unfortunately going to be over a cliff.