"Quantitative easing, credit easing and enhanced credit support aren’t working; here’s why"

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Dear readers, we are NOT setting out to have a Willem Buiter-fest this weekend. It’s simply that this is a slow news period and Buiter has a good post after the first video clip I’ve ever seen of him. So if there was more activity, the Buiter-density would be lower.

The Anglophile Dutch economist has turned to a favorite topic of mine (and doubtless many readers): why the Fed’s fancy new facilities are proving to be dubious experiments. We’ve said from the get-go (and have had tons of company, this is hardly a profound observation) that the US and its fellow financial train wreck victims are suffering a solvency crisis, but the Fed and powers that be keep wanting to treat it as a liquidity crisis. This seems to be a weird version of “if your only tool is a hammer, every problem looks like a nail” syndrome. But that isn’t the right analogy. There are plenty of things that could be done to address a solvency crisis, namely encourage writedowns and restructuring of borrower debt; selectively assist viable borrowers; recapitalize dud banks, being sure to replace management and the board, but set broad objectives, monitor, but otherwise get out of the way. But that is politically inconvenient, so the powers that be are pretending the easy way out is a viable strategy.

From Buiter(hat tip DonB):

Quantitative easing … isn’t working in the US, the UK or Japan. Credit easing – outright purchases of private securities by the central bank, which can either be monetised or sterilised – is achieving little in the US or the UK, although it has not been pushed too hard yet. Enhanced credit support in the Euro Area – providing collateralised loans on demand at maturities up to a year at the official policy rate – is not working either. These policies are not improving the ability and willingness of banks to lend to the non-financial sectors. They have had little positive impact on the corporate bond market. It is not surprising why this should be so, once we reflect on the actions and the conditions under which they are taking place.

In a nutshell: quantitative easing (QE), credit easing (CE), and enhanced credit support (ECS) are useful when the problem facing the economy is funding illiquidity or market illiquidity. It is useless when the binding constraint is the threat of insolvency. Today, liquidity is ample, even excessive. Capital is scarce. Capital is scarce first and foremost in the banking sector. A panoply of central bank and government financial interventions and support measures have ensured, at least for the time being, the survival of most of the remaining crossborder banks. It has not done enough to get them lending again on any scale to the household and non-financial enterprise sector.

Sure, as the economy weakens, the demand for credit is racing the supply of credit down, but there can be no doubt that many firms and households are credit-constrained, and cannot find external finance either from the banks or from the capital markets. Only the larger enterprises, and those with a good credit track record have access to the capital markets. Small and medium-sized firms and new firms without a credit track record cannot go the the markets. So with zombie banks and highly selective access to the corporate bond markets, we are set for a slow and anaemic recovery.

This is made worse by the poor state of household finances in many western countries. With property prices down and banks tightening credit conditions, households have suddenly woken up to the true horror of their highly indebted state. Fear and caution have taken over from optimism and an instinctive belief in the sustainability of a consumption plan financed through Ponzi finance make possible through house prices rising at a proportional rate in excess of the interest rate on housing debt. This rediscovery of prudence by households has lead to a form of Ricardian equivalence that makes tax cuts ineffective and limits the multiplier from public spending increases. Many highly indebted households have reduced their consumption to a (generally socially defined) ’subsistence’ level. Any additional income is saved or used to pay down debt.

Quantitative easing

The central bank buying longer maturity government securities will help when the underlying problem is too high a value of risk-free long-term interest rates. That, however, is not the problem. If anything, long-term risk-free rates continue to be surprisingly and damagingly low. So outright purchases of government securities by the central bank do nothing to alleviate liquidity pressures on banks, let alone the banks’ capital shortage. They are no more than a sop to the ministry of finance and its deficit financing preoccupations. At best, such monetisation of the public debt will, if it not expected to be reversed, have a ‘fiscal’ effect – helicopter money. But if households are saving their windfalls, even this will fail to boost the economy.

Credit easing

The central bank purchasing private securities outright will help if there are liquidity problems in the markets for these securities, making for excessive spreads over corresponding maturity risk-free rates. Apart from that, such outright purchases help only if the central bank pays over the odds for the securities and thus helps recapitalise the banks. No doubt the massive past liquidity injections by the central banks of Japan, the US, the Euro Area, the UK and elsewhere in Europe have taken the liquidity spreads out of the corporate bond yields. Corporate borrowing through issuance in the markets is running at a high level, even in the Euro Area. Much of this substitutes for bank finance that is no longer available. If the authorities believe that the spreads of corporates over Treasuries are still in excess of what is warranted by differences in default risk, they should be all means buy more corporate debt. If they believe, as I do, that these spreads are likely to be a fair reflection of credit risk differentials, then even credit easing is a waste of time.

Enhanced credit support

Enhanced credit support to the banks, along the lines of the ECB/Eurosystem making a humongous volume of collateralised loans to the banks (like the €442bn worth of one-year maturity repos at 1.00% performed recently) likewise only works if the Euro Area banking system suffers from a shortage of liquidity or if the ECB? Eurosystem offer too generous terms for these loans (as I have argued they do). Euro area banks take the ECB’s liquidity and re-deposit most of it with the ECB rather than using it to engage in new lending. Euro Area banks are among the most zombified by their capital inadequacy and excessive leverage.

Throughout the north-Atlantic region, the problem is not that the banks are illiquid. They are short of capital. Many of them would be insolvent but for the anticipation of further government support, on top of the massive support already given to the sector. In addition, while the fiscal authorities are prompting banks to raise more capital and have injected public capital in the wonkiest banks and while central banks are injecting liquidity in the economy on a scale never seen before, regulators and supervisors are often forcing banks to act procyclically, by building up their liquid assets now and by aggressively deleveraging now. Surely, if ever St. Augustin’s prayer – Lord give me chastity, but not yet – was appropriate, it is now for banks.

That banks are drowning in liquidity is apparent from the divergent behaviour of the stock of bank reserves with the central bank. which is increasing fast, and the broad money stock held outside the financial sector (for these purposes, the non-bank financial sector is just the off-balance sheet segment of the banking sector and should be consolidated with it). As pointed out by Ben Broadbent of Goldman Sachs (where I am an advisor – all views and opinions expressed are strictly and emphatically my own and not those of any organisation I am associated with etc.), the increase in M4 outside the financial sector in the UK has recently been much smaller than the growth of commercial bank reserves with the bank of England. Similar patterns exist in the US and in the Euro Area.


Pushing on a string is difficult. Pushing a zombie on a string is even harder. Pushing a zombie bank on a string is impossible. Unless the balance sheets of the banks are strengthened sufficiently, through massive further injections of capital, the removal of toxic assets and much lower leverage, unconventional monetary policy will not work. The banking system in the north-Atlantic region is not facing a liquidity shortage – it has got liquidity coming out of its ears. It is facing a capital shortage. Much of it still totters on the edge of insolvency. Recapitalising banks slowly through large spreads on low business volumes and through quasi-fiscal subsidies extended by the central banks in their financial support operations will take years – years of impaired intermediation and abysmally restricted external finance for households and non-financial corporations.

Recapitalising the banks and paying off private household debt through high unanticipated inflation would be possible, but undesirable. I propose a combination of mandatory recapitalisation of the banks and a debt Jubilee for the household sector to remove the two key obstacles to an economic revival. The mandatory recapitalisation would be first through new equity issuance in the market, then though mandatory debt-to-equity conversion and similar haircuts for unsecured bank creditors, and last through increased government equity stakes. All these capital injections should take the form of tangible common equity. Anything else would be cosmetic.

Subsequent regulation of the banking sector (broadly defined to include all highly-leveraged entities with serious maturity and/or liquidity mismatch on their balance sheets) will then be necessary to prevent a recurrence of the disaster we are now struggling through.

In preparation for the Jubilee, I am going long in ram’s horns. In good Torah/Biblical tradition, we should have one of these every 49 or 50 years. We skipped a few. Let’s have a big one now.

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  1. Bruce Krasting

    "There are plenty of things that could be done to address a solvency crisis,"

    Let's take a broad look at that statement. 14T in mortgages total. 10T of funded bank assets. 5t is what is left of ABS and 10T of corporate paper. Call it 40T. It is probably much more than that.

    So look at this and say we have a 10% problem. That means we need 4T in equity to fix things. We certainly do not have that much money.

    Assume it is a 20% problem and we need 8T. Sorry,we do not have that much capacity. Not even close. That is 10 years+ of earnings from the financials.

    Anything over 20% and you can just blow the whole thing up as we would need a generation to dig our way out.

    There simply is not enough 'equity' in America today to 'fix' these problems. So the only solution is to throw liquidity on a solvency problem and hope for the best….

  2. Richard Kline

    You don't push on the Blob, the Blob ingests _you_.

    A debt Jubilee . . . *hee-hee-hee* There is nothing that the masters of capital in Anglo-America would hate more than that their debt droids and wage slaves be pixie-dusted free of the chains of pixelated usury. Let's get ON with it. We have nothing to lose but our parasites. And what have they done for us lately? I mean in a positive sense??

  3. frances snoot

    "I propose a combination of mandatory recapitalisation of the banks and a debt Jubilee for the household sector to remove the two key obstacles to an economic revival."

    Isn't PPIP the bankers answer to removing sludge and keeping money in the TBTF?

    How are we to recapitalize the banks if the dollar is a worthless piece of paper backed by an insolvent government? How do we deal with the government debt? What about the Fed's insolvency?

  4. BitterRenter

    What you propose isn't "politically inconvenient", it is political dynamite. The only politically viable way to "encourage writedowns and restructuring of borrower debt" is through changes to the bankruptcy code. Otherwise you will trigger both a voter backlash and perhaps another panic in the markets.

  5. Hugh

    It is interesting how bank nationalization disappeared from the debate. For a while it was being discussed and then it was gone. Banks and government acted like pre-teens doing their version of "I'm not listening to you" until the subject was dropped.

    Our whole financial system needs a jubilee or reset. It needs to be restructured and a critical part of that remains bank nationalization.

    We have a huge load of debt and we have to decide how that debt will be redistributed throughout the system to all the players involved. As it is almost all the burden so far has been dumped on the patsy of last resort, the taxpayer.

  6. Snoring Beagle

    As I read this post I need to get the right definition of liquidity.

    We are talking about "Accounting Liquidity" in reference to the article above. Are we not? Thanks…

  7. Greg Hall

    QE isn't working because it's still a top-down approach, and our fundamental problem is an over concentration/consolidation of wealth at the "top" or the "center" and it's not circulating. We need a bottom-up, trickle-up approach, which would involve a massive debt forgiveness scheme, to renew buying power at the lower or outer strata of the consumer/business base. This is being resisted currently because it means wiping out much of the net worth of the creditor class.

  8. "DoctoRx"

    Hugh 1:08 brings us back to the key point. Dr. Buiter's diagnosis leads William Black to prescribe FDIC takeovers of the insolvent banks. Period, done, wipe out common and preferred shareholders as needed, force debt-holders to take their chances with the new equity.

    Monarchs of old could mandate a debt jubilee. What, however, is the fairness of stealing the money of the creditor who forewent the use of his/her money in order to benefit the borrower, who has already benefitted from the use of the borrowed funds? Sounds like theft to me.

  9. Greg Hall

    "Monarchs of old could mandate a debt jubilee. What, however, is the fairness of stealing the money of the creditor who forewent the use of his/her money in order to benefit the borrower, who has already benefitted from the use of the borrowed funds? Sounds like theft to me."

    A debt jubilee would be theft, but unfortunately we're faced increasingly with a Hobson's choice. Instability will likely ensue with a Dickensian scenario of doing nothing amid this Tale of Two Cities.;-)

  10. Cos

    Never heard the comment "Debt Jubilee." I get the sense its erasing the debts of individuals (or some percentage of.) But if someone else has a better definition, please post it.


  11. emca

    The general population (the grunts, as my former boss would say) of the U.S. and the bankers have one thing in common; they secretly aren't buying everything-will-be-alright meme being trumpeted by certain well known cheer leaders to the economy. As our acrobatic friend in the picture, they're squirreling away their nuts for hard times. Bankers won't chance their new found wealth via the taxpayer, households (at least a greater number than previously) won't go into debt to buy won't they don't need. This new-found prudence could in the long term be a plus, against the backdrop of an instant gratification culture, it is disaster.

    Steve Ballmer of Microsoft said a little while back that we are heading toward a new paradigm of social/economic activity. His reference was to traditional media advertising per quote

    /"I don't think we are in a recession, I think we have reset," he said. "A recession implies recovery [to pre-recession levels] and for planning purposes I don't think we will. We have reset and won't rebound and re-grow."/

    This is in no way a blanket endorsement of the wisdom of Microsoft, but Steve Ballmer does run a successful company that does depend on a broader perspective of the times, so I wonder if this particular insight, this 'reset' of the social landscape is appreciated for all the implications suggested if it were painted with a broader stroke. Whether Ballmer actually saw it reaching beyond his reference I don't know; but the thread does keep reappearing, so I'm guessing in time someone somewhere else may explore this theme more fully. Its too bad such a evaluation of the dilemma is coming or will be advocated only from the outside…it will ill serve many to speculate on a project that requires a readjustment of lifestyle and values.

  12. Dave Narby

    We will get that Jubilee, whether "they" want it or not.

    The only thing they have control over is how long it takes to get here…

  13. skippy


    I concur with the gist of your comments, a linguistic would have a field day with the terminology being thrown about today. Have not many Societal Anthropologists commented on peaks in societies and their various degrees of descent, green slope vs double black.

    Human perspective in regards to achievement (goals imposed from above), especially short term ones, always seem to bite us in the back side sooner or later. So in our political/economic higher goal orientated benchmark of the last decades, succumbed to the laws of the Universe expansion>contraction to more reasonable/stable/environmentally responsible lifestyles. Some would see this as a reduction in standing, where as I see it as a great opportunity for all. My only real fear is the battles yet to be fought by those that will lament their reduction of power/status/influence over those that carry them on their shoulders (the seagulls from finding Nemo is a fun visual aid>people of monies/power/absolute ownership, I own the property above you, so have total rights to the rivers wealth).

    BTW has anyone see the mighty Colorado river by the time it hits Mexico, a pub on Friday night has better effluent out flow.

    Skippy…If we do live in a total ownership society, why won't the owners ie: banks, insurance, bond, shareholders et al the Monies Gang and their paid for politician's take ownership of their actions. Whom is more complicit to the crime, the drug dealers or the druggies[?]and was the drug ignorance and their crime perpetrated whilst the unwashed were under its influence, umm sounds kinda like date rape to me, Repressed memory any one.

  14. joebhed

    Thanks, Yves.

    May I connect the failures of the Obamadollar legacy, as laid out by both Buiter and yourself, with the latest of Nassim Taleb's findings. He has stated very clearly lately that the economists are making predictions and recommending programs to solve the problem with the same lack of information used by the ratings agencies in the failure of their toxic "investments", if you will.

    I know I'm repeating myself, but economists really do not understand the money system, nor consider it an important policy tool. That is why the Non-systemic and actually pro-cyclical Obamadollar programs are destined to fail.
    Some day, somebody, and I think Taleb, is going to wake up and declare that it is the money SYSTEM that is insolvent.
    The debt-money system is insolvent.
    How many folks at the Fed, and how many folks at the BIS, do we think are working on the exit-strategy away from the debt-money system model that we foisted on the world in 1944?
    There is not enough debt-money IN the debt-money system to make the payments ON the debt-money that is already out there.
    If that ain't the definition of insolvency, I don't know what is.
    It's an Achilles Heel kind of thing.
    Exit Strategy.

  15. Todd Wood

    Taleb's latest video (re: employment number's) is here:


    He says that we still have 40 to 70 trillion more to de-leverage. Is he right?

    If so, how come committees and committees of committees are not being formed to plan an orderly unwinding? I'm shocked. Obama should use the bully pulpit standing risers and on a pile of phone books to lead us through.

    Hey, dye the Potomac red, whatever!

    Cheese and crackers…

  16. Avl Guy

    To @Cos:
    I first came across a "Biblical Debt Jubilee" in Jan-Feb when it was used by the British finance columnist Ambrose Pierce-Evans at the Financial Times.com. As I am 'biblically-challenged', a bud offered up the biblical story of a regularly scheduled debt jubilee mandated every 40 (take or give?) years…when all debts were forgiven. In effect, a hitting of a reset button for that generation(s) who were annually being saddled with more & more debt.

    I think domestic and global politics are far too messy for anything as tidy & neat as a debt jubilee. I see a cascade-effect of sovereign defaults begetting commercial defaults begetting sovereign defaults worldwide, culminating in a US sovereign default. EXCEPT, we're far too good at 'wordsmith' so just as our military doesn’t not grant anyone 'permission; to call innocent civilian deaths anything other than 'collateral damage'…I see something similar mandated here…it will be wordsmithed into something clinical and harmless-sounding like mutually-agreed upon quantitative easing of long-term obligation.
    On second though, just call it a Biblical Debt Jubilee…it sounds sanctified and much more festive.

  17. Brick

    For me the interesting thing about QE is that it highlights certain weaknesses in the economy and policies of those implementing it. Firstly the ECB action which is questionably QE seems to show a lack of current liquidity or more probably was directly aimed at certain banking sectors like Sweden, Spain, Austria and Italy where banks probably risk insolvency. This seems to me to be a kick the can down the road measure.
    The UK QE seems to be mainly about Gilts and the fiscal deficit. Since a large proportion of spending in the UK is the social safety net, I would guess this highlights some of the serious imbalances in the UK safety which the current government is so proud of. A safety net where a one parent family with one child doing part time work gets virtually nothing and a professional claimant with numerous kids get the big house, loads of benefits and all the opportunities going. Targeting child poverty is a good thing, just not when it introduces the level of moral hazard that the UK government has introduced.
    The US QE is directed partially at agency debt and partially at treasury debt to keep interest rates low. This is all about sustaining the imbalances in the housing market, and in effect is a way of increasing the subsidy to home owners.
    Non of these will really work because they don’t target demand which is most probably best helped with short term tax reductions. This is why the US is in bigger trouble than anywhere else because politicians have an inability to increase taxes in the US when the time is right so they back away from the short term action that is needed.

  18. In Debt We Trust

    Don't forget unemployment – Q.E. doesn't solve unemployment. Maybe it will create/preserve a few protected staff among govt but the private sector reacts to reality –

    when there is a lack of demand for a given product/service, why should business owners rush to stock up on what is essentially excess capacity?

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