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Michael Hudson: QE3 – Another Fed Giveaway to the Banks

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In this Real News Network interview, Michael Hudson gives a high level discussion of why the Fed’s claim that QE3 will help employment needs to be taken with a fistful of salt. Hudson highlights an issue that warrants more attention: that the Fed’s action, at this juncture, is clearly political, when the Fed continues to make the empty claim that it is “independent” meaning apolitical. Hogwash. The Fed quit being apolitical under Greenspan, as former Fed economist Richard Alford pointed out in 2008:

Compare the behavior of the Chairmen of the 1950s and Volcker to that of Greenspan. Chairman Eccles and McCabe both lost their Chairmanships because they wouldn’t compromise Fed independence. They stood their ground even after being summoned to the White House. Martin, appointed by Truman, was in later life referred to by Truman as “the traitor” presumably for taking the punch bowl away. The public image of Volcker is that of a man who twice a year endured public Congressional assaults, resisted political pressure, and enabled the Fed to stay the course.

Greenspan, on the other hand, jumped at the chance to meet Clinton, traveling to Little Rock before the inauguration. Bob Woodward in his book “Maestro” quotes Clinton telling Gore after the pre-inauguration meeting: “We can do business.” Woodward also quotes Secretary of the Treasury Bentsen telling Clinton that they had effectively reached a “gentleman’s agreement” with Greenspan. The agreement evidently involved Greenspan’s support for budget deficit reduction financed in part by tax increases. It is not clear what Greenspan received.

Even if the deal with Clinton contributed to a good policy mix, Greenspan should never have entered into that agreement/deal/understanding or another agreement/deal/understanding. The very act of negotiating and injecting the Fed into a discussion of budget decisions compromised Fed independence. Why shouldn’t Bush have expected the same? Why shouldn’t every succeeding President expect the Fed Chairman to be a “business” partner? Refusal to deal on the part of the Fed can no longer be attributed to principle and precedent. Refusal “to do business” will now be viewed as a rejection, partisan or otherwise. The Fed is no longer able to stand apart from political battles. Greenspan severely compromised the Fed standing as an agency insulated from the short-sighted and partisan politics of Washington DC.

Greenspan risked the NASDAQ bubble during the Clinton years (part of the quo for the quid?) and more recently implicitly accepted the risk of a housing bubble as he touted ARMs as the Bush Administration and Congress promoted the ownership society. Financial innovation was lauded while it produced short-term gains. The Fed failed to adequately pursue its regulatory responsibilities as it kept rates low, despite the relatively high levels of leverage, derivatives markets that dwarfed the underlying cash markets, breakdowns in lending standards and credit spreads that even it didn’t think compensated for the risks. Like Greenspan, the current Fed implicitly decided to risk long term stability rather than incur short-term costs. With globalization holding down measured inflation, it seems that no risk was not worth taking.

After failing to use the independence granted to it by statute, the Fed is now pushing the bounds of its legal authority. It is making decisions that might better be reserved for elected officials. It argues that these steps are necessary, but the Fed is being drawn into the micro management of credit allocation and income re-distribution — a far cry from “inflation targeting”. The Fed is willingly injecting itself into areas that are the provenance of the Congress. Congress has not objected yet, but it will when it is to Congress’s advantage. Will it have costs? How does monetary policy designed by the people responsible for the tax code, fiscal deficit and Federal debt sound?

Greenspan had very considerable political skills, but he did not use them to maintain Fed independence or insulate the Fed as it took policy steps that imposed short-term costs. He curried political favor and opined on issues other than monetary policy.

And now to the talk with Hudson:


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51 comments

  1. kevinearick

    And we come full circle, back to tall paul’s true/false assumption of goodwill, when he helped seperate gold from the dollar to increase float, namely generational degredation. goodwill cannot be legislated, but peer pressure ensures degredation. goodwill is a quantum effect, learned, as he learned, in the practical school of hard knocks. his grandson, however is one of yhe robots, doing what he is told, subjected to societal propaganda from birth
    now, the global economy is trapped in a digital catch 22; parents of goodwill must train their children, but at 15% return to labor, with the entire momentum of the empire jack hammer behind it, precious few, always the most valuable commodiyy can afford to be of goodwill, to turn peer pressure on its head.

    as the numbers succumbing to peer pressure grow, so to does the weight on the shoulders of those effectively resisting it on the othet side, as complexity of misdirection, shory term thinking increases.

    in his day, children would line up to listen to the old man. today, they line up to buy an apple…so they can buy another, slightly different apple tomorrow. Newton wins in the short te, which is most of the time. galileo wins infrequently, but is more decisive. what you are looking at now is a microwave, cooking the economy, indecisive anxiety with no where to go.

    1. Tao Jonesing

      And one day, everyone will wake up and realize that the economy is just make believe. That money is nothing, whether backed by gold or not.

      We are killing ourselves to maintain a fiction.

      1. Marley

        ‘Tis true… but many people (including myself) working to make that day come… we’re getting there, but awfully slowly and painfully. It’s important not to give up, though. The voices of reason are growing in number and volume.

  2. MyLessThanPrimeBeef

    I think it’s more than just letting the lord of the manor exercise his signeural rights.

    (How can the feudal economy grow if the fat lords are not fed first, the very learned once asked.)

    Instead, I think the Fed is saying this: The only fear we have to fear is that the peasants are not gambling enough. We want them into risky stuff.

    1. The Rage

      No, what the FED is saying is: Short term rates are to high in markets and long term rates are to low hurting growth……..so we need to satisfy the demand in the short term to get the market to create investment vehicles that satisfy in the long term. But the FED doesn’t speak it that way, which confuses people obviously.

      That way economic growth recovers and nominal long term rates rise boosting pensions.

      I see it in home construction markets right now. Demand is calling for more homebuilding over the current production, but jittery financial markets are holding back builders, which in turn is causing housing prices to surge…..unhealthy. QE3 may ease the financial markets to lower rates and thus normalize their business models. Which will then have people leave overbloated government debt markets.

      1. ambrit

        Dear The Rage;
        What markets are those? All I see from the Deep South is shadow inventory being withheld from the market to prop up prices. A stealth bubble as it were.

    2. JP Shannon

      Jolly numbers – accounting fiction – criminal fraud – Massive Manipulation of Public Opinion!
      In 2008 Wall Street in a matter of days became “Legally Insolvent” due to the accounting fiction of off balance sheet financing which Congress enabled! All Investor Capital got wiped out! The Fed was forced to Liquefy the banks with TARP$ TRILLION$! Go do your home work and write about that fact!
      QE continues on! Its only goal – to provide Wall Street with the “Liquidity” it needs to keep on stealing from “We The People” as it takes our 0% money and loans it back to us!
      Too bad “Main Street” can’t get that deal!

  3. Dan Lynch

    I’m a big fan of Michael Hudson, but I’m not sure that I can agree with him on this subject.

    QE does not “give” money to banks, as Hudson claims. QE BUYS Treasuries or government backed MBS’s. The effect is to raise the selling price of those Treasuries and MBS’s, and lower interest rates.

    The banks may well be speculating in foreign currencies and whatnot, but they can do that even without QE.

    Yes, there are some side effects of QE and ZIRP — it drives investors out of safe Treasuries and into “gambling” in riskier investments. It hurts pension funds. It may pinch consumers by raising commodity prices. I don’t like QE for all those reasons.

    But QE does not “give” money to banks.

    1. The Rage

      Yes, this is not one of Hudson’s better pieces.

      QE3 is actually, quite quite small starting out, it would take years for it to build up and that won’t create much inflation directly, unless markets decided to go gonzo, which would end the program. I would also argue, irrevelant unless the market wants to force the governments hand and print out currency for the purchases. Other than that, it is electronic IOU’s.

      The Asian slowdown has started to effect things globally which means less commodity inflation.

    2. Yves Smith Post author

      He’s not at all specific re mechanisms, but this round of QE is aimed at mortgages, which is keeping all mortgage related asset prices high, and THAT includes just under $400 billion of second liens held on bank balance sheets. And on top of that, as we have discussed in other posts, the banks aren’t lowering their yields on new mortgages to reflect the fall in secondary market mortgage prices. So that DIRECTLY increases bank incomes. In that respect, it does give money to banks. The failure of banks to pass on the lowered borrowing costs existed before QE (you also see it in credit card spreads). The Fed knows damned well about it and it not pressuring the banks. So the fattened margins are a feature, not a bug.

      Don’t be so quick to accuse Hudson of being wrong, as opposed to incomplete.

      1. jake chase

        Since Nixon closed the gold window (1971) the Fed’s only real (as opposed to fanciful) purpose has been to protect the interests of the major banks. Volker is conventionally extolled as an exception, but that is bushwa. His concern was not inflation but the banks’ exposure to Mexico. His regime cratered the real economy but was instrumental in bringing Mexico sufficiently to its knees that default was not an option.

        The Fed was never designed to be an agency of government. For the first twenty years of its institutional life it unashamedly made a profit for its largely foreign owners. It was the brainchild of the Rothschilds and their American surrogate, JP Morgan, and was put across by the faux Progressive, Woodrow Wilson, whose essential role was to be Morgan’s stooge.

        The Fed is part of a deal that cedes financial power to the banks in exchange for buying endless quantities of government securities. Nobody ever considers that in a sane political system there would be no need for the US government to borrow money. We remain dedicated to an insane political system, and criticizing the Fed for QE3 is like abusing a teenage drug addict on account of his couture.

      2. Dan Lynch

        Agree that the MBS purchase is a favor to the banks, but remember that the Fed can only purchase MBS’s that are insured by the government.

        This is not the way I would go about dealing with those mortgages, though. Better to help homeowners by writing down the mortgages rather than inflating the MBS’s and the housing market. By having the Fed prop up the housing market, this is in effect a backdoor bailout for the banks who are holding all those questionable MBS’s.

        I agree with Hudson in sentiment, but I would not phrase it the way he does.

      3. Ben Johannson

        Average yield of a mortgage is between 3 and 4%. So the Fed swaps these for reserves which banks will have no use for. Those banks will then keep those reserves in their Fed accounts earning the support rate of a quarter point. QE is reducing bank and private sector incomes not increasing them.

        1. Tim

          No, the amount the banks are getting for despositing their reserves at the fed is way more than .25% and one of the primary means of the Fed recapitizing the banks other than by asset inflation.

          .25% is the overnight lending rate.

    3. pebird

      Well, if I sell you something that is worthless, and you know that it is worthless, what is the difference between that and giving me money?

    4. steelhead23

      Pay attention. In QE3, much like QE1, the Fed is buying MBS – almost assuredly at face value. These are likely to be securities including lots of underwater properties and delinquent loans. Such securities may be worth half their face value on the open market, if that. Hence, they will be magically making those “mark to fantasy” balance sheets come true. Exactly what is your definition of giving?

      1. Dan Lynch

        Yes, the Fed is propping up the housing market and MBS’s, but remember that the Fed is only allowed to buy mortgages that are insured by the government, so the taxpayer would be on the hook for those mortgages even if the Fed didn’t buy them.

        This is not the way I would prefer to deal with the mortgage problem, though. Better to directly assist homeowners with some sort of debt writedown or Keen-type jubilee.

      2. Ben Johannson

        It doesn’t matter. The Fed is buying them with reserves, which have limited utility. Banks can’t take them and pay out bonuses or do much of anything else other than buy government bonds. Any excess reserves on bank balance sheets sit there effectively useless, earning a support rate a fraction of the rate of inflation. This will hurt banks more than it will help.

        1. F. Beard

          The reserves are not useless. They can be used to buy more US sovereign debt or even foreign debt according to Hudson and at least in the case of US sovereign debt that debt can later be resold to the Fed for another round of buy low, sell high. This is stealth recapitalization of the banks.

          BTW, in the case of the Fed buying MBS (with new reserves of course) why shouldn’t the mortgage debt backing that MBS be forgiven since the investors are made good? Why should those mortgage payments leave the economy by disappearing into the Fed?

          1. Susan the other

            Or is the Fed continuing to perpetuate the lie that these MBS are securitized and the servicers are legit. So when the Fed “buys” MBS” what exactly is it buying, just a middleman fee?

          2. F. Beard

            I think the Fed is buying crap with the hope that the new money will “trickle down” via the “wealth effect” and thus make the crap good.

      3. Garrett Pace

        This is what I’ve wondered about. Always assumed that these MBS’s were unsellable at face price and this amounted to a backdoor bailout.

        It means the banks can realize a profit on the instruments and give great big bonuses for a job well done.

        w00t.

  4. The Rage

    Another thing I find funny about QE3, its effects won’t be felt to just after the election……………if it works.

    Husk Husk

    1. Tim

      Clearly you don’t follow the stock market much. It’s already mission accomplished. Romney is toast even without his 47% gaffe.

  5. Mary Bess

    Help me. Isn’t what we have a hostile takeover by banks of the government, facilitated by politicians starting with Clinton?

    1. Doug Terpstra

      Ding ding ding! The winning question answers itself. It is a convenient alliance of collusion between the 1% and their Washington wannabes.

  6. Shizel

    Hudson did not clearly answer how the Fed was helping Obama, let alone why. QE in the face of the upcoming food inflation will restrict its impact.

    1. Aquifer

      The only thing that occurred to me was a ? qpq – helping the banks who will, in turn, help (fund) Obama and ? tweak the markets to present a better picture of the economy before the election … ??

  7. jim beene

    “The public image of Volcker is that of a man who twice a year endured public Congressional assaults, resisted political pressure, and enabled the Fed to stay the course.”

    It was Volcker in the Carter administration who recommended changes that made posible the avalanche of deregulation under Reagan.

  8. Doug Terpstra

    Alford’s intro premise is downside-up. It confuses puppet with puppeteer, IMO. The Fed has not lost independence — Washington has, utterly. Yes, the collusion is in-your-face obvious, and the president is a willing accomplice, but the Fed wields the whip. The president, congress, judiciary, and media are captured and subservient to the Fed/Wall Street/AIPAC, not the other way around. That should be crystal clear in the timing of QEX and the election-eve collusion with the ECB and IMF on Obama’s behalf. Obama is merely a self-important, narcissistic idol on a gilded throne — malevolent he may be, but he’s not the real power.

    “Give me control of a nation’s money and I care not who makes its laws” – Mayer Amschel Bauer Rothschild

    The perpetuation of the persistent myth that the Criminal Reserve Cartel is independent of politics in the public interest only disguises the real perps, the cartel’s own parasitic cronies, gambling and skimming obscene usury from the rest of the world. Like naïve children watching an imperial charade, even us finance-challenged rubes can see that this corpulent emperor is buck-naked . . . and butt-ugly. Why do serious analysts continue to promote the myth of Fed independence rather than exposing its actual dominion? Anyone?

    Hudson, OTOH, nails it. He cuts through the BS propaganda. He clearly knows who runs things, and it’s certainly not the fork-tongued teleprompter:

    “It’s as if the crooks have taken over the economy and are trying to bail themselves out of the mess that they’re in.” “There is no connection to employment whatsoever”. This is not about jobs, plural — only one: for the guy playing Trojan horse.

  9. allis

    Coincidentally, this weekend a friend asked me what I thought about QE. Below is the answer:

    Interesting challenge you gave me…what do I think of the latest round of QE? I went on the internet to learn more about it, and picked up the official party line, which I won’t repeat. It took me a while to figure out that the official party line was nonsense: QE never has done anything to get more money into the Main Street economy, nor, I suspect was it ever intended to do so.

    First; the short answer to your question: QE is a way to provide casino capitalists with the stakes they need for their gambling activities.

    Somewhat longer answer: QE is a way to enable the banks and broker-dealers who are the “Shadow Banking System” to exchange their near worthless “securities” for government securities, whose values are upheld by the government’s power to divert wealth to the Shadow Banks from Main Street, either through taxation or, preferably, through “austerity.”

    QE is a way to put money (liquidity and solvency) into the Shadow Banking System (SBS). (The Wikipedia article on shadow banking is very good). The SBS consists of “financial institutions and legal fictions” that are outside the regulatory authorities. It includes “hedge funds, structured investment vehicles (SIV), special purpose entity conduits (SPE), money market funds, repurchase agreement (repo) markets and other non-bank financial institutions.” Many of these entities are “off balance sheet” activities of the too-big-to-fail-banks (although two did fail, Bear Stearns and Lehman)

    The SBS plays “an important role in providing credit across the global financial system.” To create this credit (money), collateral is required. Simply put, loans can be given, and in the process money “created,” if borrowers can provide collateral. Some five years ago it became obvious that much of the collateral (“securitizations” (bunching together of many mortgages into MBS, mortgage backed securities)) was of unknown value, and in many cases close to worthless. As a consequence, there was a “run” on the SBS. International markets froze.

    Funds from TARP and then QE replaced many of the bad securities (“toxic waste”) with good government securities, so that the SBS would have decent collateral and global markets could continue functioning.

    Contrary to the propaganda used to justify TARP, most of TARP was invested in emerging economies or used for “trading” in foreign exchange and other global markets. Apparently, very few of the TARP funds, or later, of the QE funds, made it into the Main Street economy. These funds did, however, do wonders for the shadow banking system:

    “By late 2007 the size of the SBS in the U.S. exceeded $10 trillion and by late 2011 had increased to $24 trillion according to the Financial Stability board. Globally, a study of the 11 largest national shadow banking systems found that they totalled to $50 trillion in 2007, fell to $47 trillion in 2008 but by late 2011 had climbed to $51 trillion, just over its estimated size before the crisis. Overall, the world wide SBS totalled to about $60 trillion as of late 2011.”

    If I figure rightly, 60,000,000,000,000 (60 trillion) divided by a world population of 6,000,000,000 (6 billion) comes to $10,000 for every man, woman and child on the planet. Are they kidding? Are we in a mad house or what?

  10. Teejay

    Can you elaborate/clarify on “measured” inflation vs nonmeasured. The up & downsides of each. Who “wins” & who
    “looses” depending on which metric used.

  11. Acadiana

    Michael Hudson is both right and wrong. He’s right that *some* of the low-rate funds the banks have received has been used for various forms of interest rate arbitrage, but… net/net low rates are no longer helping the banks; they are hurting. Low rates were helpful when the banks needed liquidity and needed to shore up capital and credit quality. That ceased to be the case 12-18 months ago. Today, low rates are killing the banks’ net interest margin. I’d bet that 9 of 10 bankers today would prefer to see rates 300 basis points above current levels because they’re almost all asset sensitive and low rates stopped benefitting them a while back (improvements in credit quality are now more than offset by margin contraction in the profitability equation). I think Bernanke’s *trying* to stimulate demand (and thus, employment) – trying to get businesses to borrow and expand – and the banks want to make loans, but… the demand just isn’t there. Most businesses don’t want to borrow even at today’s low rates. Which is why keeping rates low just ain’t gonna do much good from here on out… unfortunately. But, Hudson’s dead wrong about Bernanke helping the banks at this point (although that was clearly the case for the first several years of easing during the crisis and after) – he’s doing the opposite.

      1. Acadiana

        Yes, we have too many banks. The biggest are too big (but unlikely to be broken up) and the smallest are, on average, too small. Currently there are about 6,700 regulated, for-profit depositories in the US (this excludes about 8,000 credit unions, most of which are very small). I can’t imagine we need more than half that number (or less). The challenge is how to continue to consolidate without the largest banks getting even bigger…

  12. Susan the other

    Just thinking about PP’s rundown of 1840 to 1900. The banks were forced to actually compete as private banks. So clearly when they came together in 1913 to form the Fed, a private banking consortium with a hidden dependence on the government, it was out of desperation and failure – which could not be admitted. Right? Why else? So how clever. Rothschild certainly had a multi-generational memory of better times when his family had private money it loaned to kings and princes. But capitalism and trade had ruined all that. The banks needed to form a coalition with government, plain and simple. And then they screwed the pooch and brought us in rapid succession: WWI, the bloated Twenties, the Great Depression, and WW2; followed immediately by a dysfunctional financial system that could not pay for itself even with government largesse and so it imploded in 1970, going off the gold standard or god standard or whatever – so that there was nothing left of finance except pure politics including all the pious pretense. Pure politics. Don’t tell me there is a difference between monetary and fiscal.

  13. TC

    Excellent interview, and I agree with Hudson’s take that the Fed is facilitating asset grabs on the cheap. As for Alford’s comments on Greenspan, I think he misses the mark and should be regarding the man a shyster whose rightful place is sharing a prison cell with Madoff.

  14. jerry

    It’s been difficult for me to figure out the nature of these ‘excess reserves’. For the 50 years prior to the 2008 crash, it appears that excess reserves were basically zero, and now we’re over a trillion. I understand that they correspond with all the treasuries and MBS purchased by the Fed over the past few years, but what are the restrictions on these reserves? Why doesn’t Blankfein and the board of directors just write themselves checks for billions of dollars each with the money, or buy up entire companies? Or do the reserves have to remain in a liquid, short term asset?

  15. Hugh

    The Fed is committed to paying out to banks indefinitely almost half a trillion dollars a year in exchange for overpriced, illiquid dreck. I fail to see what’s complicated here or how this is not an enormous subsidy to banks.

  16. B Comenius

    The Political framing misses the point of the story. The real news here is Greek natural resources are now on the market. And, these Creditors will profit from the crisis premeditated by Goldman’s derivatives for the Conservative Greek Government that refused to raise taxes on the Greek 0.1%. We see the pattern here. It has worked this way time and time again. The asset grab finally begins! This is the real story of this fractional-reserve debt money Bubble Bust system. And, we had better wise up. It is coming here soon once this currency loses reserve status! All this expansion of Base Money sets up conditions nicely for rapid expansion of the money supply when the speculators want to borrow that money to short the dollar.

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