Immaculate Deception, Fed Style

Yves here. How the Fed tries to covers its huge pro-bank bias.

By Edward J. Kane Professor of Finance, Boston College. Originally published at the Institute for New Economic Thinking website

During the years leading up to the Great Financial Crisis, Fed officials began to tell outsiders more and more about what members of the Federal Open Market Committee (FOMC) were thinking in setting operative interest-rate and price-level targets. My new INET Working Paper is adapted from a chapter in a book I am now writing. It treats the flood of selected policymaking information released by the committee after each meeting as misleading patter meant to distract the committee’s audience from observing the hard-to-defend cumulative effects Fed policies have had on the distribution of income and wealth. As in stage magic, lobbying activity that determines how differently FOMC policies actually impact the rich, the poor, and the middle classes still takes place behind an informational curtain.

Today, as during the Great Financial Crisis, the Fed’s policy strategy has been to prevent open insolvencies at US megabanks by making subsidized loans to US megabanks’ insolvent foreign counterparties (and to the foreign taxpayers that would otherwise have been asked to rescue them). At the same time, Fed leaders have resisted a broad-based bailout of insolvent US homeowners and landlords. During the GFC, they stood by as US banks foreclosed on all but a few privileged categories of distressed mortgage borrowers. Although households are receiving some help in the current go-around, forbearance is not forgiveness. Unpaid rents and mortgage payments are still mounting up.

The overwrought praise that Wall Street and the media subsequently heaped on Treasury and Federal Reserve leaders for being willing to punish lower-income households to get the rich through the Great Financial Crisis established a nasty precedent that is guiding monetary policy today. This unspoken precedent is “Bankers and Brokers first.”

A precedent is a previous event or action that sets a standard or guide for how one or one’s successors should (and therefore probably would) act in similar circumstances in the future. The 2008 troika of Bernanke, Geithner, and Paulson congratulated themselves for having the “courage” to put the interests of foreign bankers and major US financial institutions (including a few of its automobile makers — think the airlines and tourism industry today) ahead of ordinary US citizens. The victory laps that Barney Frank and Chris Dodd are taking this week for passing Dodd-Frank not only celebrate this approach, but provide opportunities for them to claim that they rescued rich and poor alike from complete and utter ruin [see, e.g., Bernanke, Geithner, and Paulson (2018)].

This portrait of distributional neutrality is propaganda of a high order. Current and former Fed and Treasury officials cannot fail to understand that, in accepting so much adulation, they have cemented a series of dangerous precedents. If public-service norms were more evenly balanced, instead of simply accepting praise, they might feel an obligation to identify the downside of following their lead in the future.

Aggressively devising creative, nontransparent, and arguably extralegal ways to transfer massive amounts of US taxpayer resources to wealthy stakeholders in zombie megabanks around the world is a dangerously elitist strategy. An important fourth crisis manager was left out of the celebration: former FDIC Chairman Sheila Bair. This was in large part because she was only a woman and because in Bair (2019) she dared to argue that, if future crisis managers were to distribute rescue costs in the ways the troika did, they were bound to encounter the kind of angry protest movements we are seeing today.

With a wink and a smile, bankers, regulators, and politicians assured us all in 2010 that a few carefully crafted words in the Dodd-Frank Act (DFA) could and would prevent generous anti-egalitarian taxpayer support from becoming available to the financial industry in the next crisis. Contrary to centuries of experience in the banking industry, the Dodd-Frank Act asks us to believe that governments can prevent crises by merely asking banks to post more (and possibly better) capital on their balance sheets. My research establishes that accounting-based requirements lose force the longer they are in place. This is because accountants take it as a challenge to circumvent them and in fact do this better and better the longer a particular rule stays in force.

In the decade since the DFA was enacted megabank lobbyists have sped up the natural rate of capital-requirement decay by convincing regulators of the need to “custom tailor” accounting formulas to the special circumstances of different categories of banks. Each nick and tuck that regulatory tailors devise in the way capital requirements are calculated open new and often unintended loopholes for other classes of financial institution to exploit.

Loopholes are part of any regulatory system. To make them hard for the public to see, bankers prefer that regulatory benefits be distributed in implicit ways. By that, I mean access to these benefits is based on understandings about how regulators should and will react in crisis circumstances. In the Covid crisis, the bogus restraints celebrated in the DFA have—as my 2012 paper predicted—simply lost their teeth. Bank examiners and accountants were directed to soften loss recognition and the Fed went on to devise (at last count) 14 openly discriminatory lending programs aimed at preserving particular classes of financial contracts and interests.

Confidence in the availability and sustainability of implicit safety-net support creates powerful incentives for megabankers to pry themselves loose from the bite of capital requirements and other regulatory restraints over time. This is the central message of my research career. I have asked readers to picture the mix of endless opposition and circumvention that financial rulemaking and enforcement entails as a dialectical process. After each crisis, sponsors of tougher capital requirements and other elaborate rules claim to have found ways to force bankers and their creditors to stay strong enough to absorb losses more or less as they occur. But sponsors seldom acknowledge that corporate-level restraints are bound to fail eventually. Placing accounting and other kinds of restraints on banker behavior fail because they do not directly attack either bankers’ appetite for tail risk or regulators’ incentives to forbear when times get tough.

Experience teaches us that corporate-level reforms do not and cannot hold their effectiveness over time. Rules beget regulation-induced innovations and these burden-reducing innovations become more and more successful over time. The difficulty governments face in devising and enforcing appropriate punishments for individual bankers that knowingly exploit safety-net protections converts national and regional safety nets into what amounts to a global Protection Racket operated by —and for the benefit of— thieving megabankers. My new paper explains how governments could make this racket far less profitable if for some unlikely reason politicians might conclude that toughening fraud laws would be a good thing.

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  1. PeasantParty

    I am looking forward to reading this book, for sure! How the Stock Market affects people and Main Street is something every person needs to know. QUOTE “As in stage magic, lobbying activity that determines how differently FOMC policies actually impact the rich, the poor, and the middle classes still takes place behind an informational curtain.” Hopefully, your writing will compel others to report on a mainstream level the facts that have been hidden behind those curtains ripe with insider trading, and Corp. tit for tat.

    “Bankers and Brokers First” INDEED!

      1. chuck roast

        I have recently taken to wearing my old IWW t-shirt around. “An Injury to One is an Injury to All”

        1. Ed Kane

          Very evocative. I would urge you find and post enough additional pictures of the revolution to bring the total to 1789.

  2. Henry Moon Pie

    The Fed is attempting to preserve the current complex and fragile system of control in the United States. To oversimplify, workers report to employers, and employers, as present and hopeful future debtors, report to bankers. Everybody reports to holders of equities and bonds, i.e. the billionaires.

    So obviously, if your main and really only goal is to preserve the current system of control, then you take care of the people at the top. Workers are expected to scramble for survival as these bailouts distort asset values, including housing prices.

    With the GFC, these bailouts strengthened the existing system of control though it greatly increased dissent and dissatisfaction among the even more subjugated working class. This bailout has the virus as an opponent, however, and cannot achieve what the Fed, the banks and the billionaires hoped. They’ve only delayed the inevitable while intensifying the hatred felt by most against this system.

    1. William Wald

      Agree! The Fed is working within their mandate to do the job that congress refuses to do.

      It boggles my mind that the “experts” refuse to admit that MMT describes the world economy since at least 1972. Is it because they are afraid to admit they are wrong or because it is in their financial interest to crash the US dollar?

  3. William Hunter Duncan

    It is not just media and the bankers hiding their thievery by obfuscation. Every opportunity I have, since 2008, I talk to people about how the Fed has handed out so many Trillions of made up from nothing money every time there is a crisis, to the most elite players. So the elite win on the front end and the back end, and own more of the economy over time.

    It is not just Republicans who have no ear for this. Liberal Democrats almost invariable act as if I haven’t said anything at all. If they respond they often talk about how TARP saved the economy and all the money was paid back. QE saved their 401k/pensions apparently, so they instinctively pretend it never happened, just as the Fed would have it. It is the same today. I mention that the Fed has said unlimited bailouts for the biggest players, Republicans start complaining how unemployment is for dirtbags who don’t get it, and Dems act as if the CARES Act was all about small business and regular people.

    I have yet to hear anyone associated with BLM say a word about the Fed.

    Some people do know that the Fed facilitates austerity for the many and every advantage for the few, but invariably they act like that is just how it is and always has been, so there is nothing to be done about it.

    1. Kurtismayfield

      QE saved their 401k/pensions apparently, so they instinctively pretend it never happened, just as the Fed would have it.

      Whoever came up with the 401k was a genius.. make profit off of cash that would have gone to pensions, while pushing the liabilities off their books. Oh and as a bonus you get 20% of the population to side with investors all the time..

      1. Oh

        The carrots for the people were: 1) tax deferrel 2) so called employee contribution. The sticks were: 1)No pension 2)Limitation on employee payout 3)Get shacked by Wall Street
        Bonanza for Wall Street 1)To manage play with your money 2)Get your private info.
        3)hold on to your money and misuse the fiduciary responsibilities. Employers got off for a lot less!

  4. flora

    Thanks for this post.

    My new INET Working Paper is adapted from a chapter in a book I am now writing. It treats the flood of selected policymaking information released by the committee after each meeting as misleading patter meant to distract the committee’s audience from observing the hard-to-defend cumulative effects Fed policies have had on the distribution of income and wealth.

    I remember reading selected comments and longer papers from heads of the Minneapolis, the KC, and the Dallas fed banks – districts 9,10, and 11 – during the height of the last crisis. The publishes statements from these guys sounded like there was real debate and some common sense in the FOMC meeting, and gave me some hope about the outcomes. But…. maybe those statement releases were part of a carefully staged presentation. Not that those district bankers weren’t right or weren’t actually working for better outcomes, but it sounds like the fix was in from the beginning, as the saying goes. Might explain why things always went only in one direction. Good to know.

    1. flora


      Bank examiners and accountants were directed to soften loss recognition and the Fed went on to devise (at last count) 14 openly discriminatory lending programs aimed at preserving particular classes of financial contracts and interests.

      Ah… the real Special Interests. ;)

  5. Susan the other

    Blaming the Fed is our first mistake. We should be blaming Congress from start to finish. I agree with this post and the comments entirely except for the fact that nobody blames Congress. We need deep structural change, as Liz Warren has stated. She also stated that she is a devout believer in the Market. So I don’t see how she can change one without changing the other – What we need in order to bring about deep structural change is a significant reduction in the profit motive, for starters. When the Europeans decide they’ll disburse funds for the Coronacrisis, but insist that those funds must be borrowed from the Money Markets, I can only ache with disappointment. Imo, money should never be “marketed” for social spending – that’s the second mistake. But it is so intrinsic to our neoliberal capitalist ways nobody can consider changing it. Because profits. It’s wallpaper to merely change the mode of prioritizing the redistribution of money – all the old problems will keep recurring (as in the post). What we need as of yesterday is a true change – a true structural change for a secure democratic fiscal component of sovereign social spending into the economy; this needs to be safely apart from private for-profit banking (because private banking in turn churns up egregious corporate profits that exploit people and behave in ways which have nothing to do with choice or price discovery or the whole idea of a market at all). I think our system is more than immaculate deception – it is a fear close to panic at this point.

    1. Lil’D

      While I agree that Congress deserves the bulk of the blame, the Fed had choices and they resolved in favor of “Wall Street “

      It would not have been hard to cheaply support millions of homeowners

  6. ChristopherJ

    Our own RBA refuses to acknowlege MMT without dismissing it as ‘ludicrous’ or other such strawman argument, usually with the old – it leads to inflation argument.

    Fails to see how central banks can facilitate much needed fiscal stimulus (which the economy can clearly absorb without inflation);
    Fails to acknowledge that we have had one of the biggest inflationary periods ever, in terms of things we need, but little inflation for things we need (like a wage to keep up with it all); and
    Fails to state clearly that they operate to keep the banking sector well funded and profitable.

    As for the Fed, I don’t think enough people understand the nature and size of the theft that has just occurred and been facilitated by your politicians. Everyone seems amazed and how disconnected the stock market is from the American economy. Gold and Silver too.

    Everyone should realise that it ain’t prices going up, it’s the dollar going down and it will pick up pace as less and less people want to hold it. Covid is just accelerating the inevitable and the worst thing is that no one can get out of the USA, unless you have a private jet and connections

  7. Sound of the Suburbs

    Central bankers make financial stability look a lot harder than it actually is.

    In the Keynesian era they could still remember what GDP actually was and there were hardly any financial crises. They didn’t think they were creating wealth by inflating asset prices.
    The FT did a timeline of financial crises with each one marked by a vertical bar. There were lots before the Keynesian era, and lots after the Keynesian era, but hardly any during the Keynesian era.
    “This Time is Different” by Reinhart and Rogoff has a graph showing the same thing (Figure 13.1 – The proportion of countries with banking crises, 1900-2008).
    This is actually the secret.

    At the end of the 1920s, the US was a ponzi scheme of over-inflated asset prices.
    The use of neoclassical economics and the belief in free markets, made them think that over-inflated asset prices represented real wealth accumulation.
    1929 – Wakey, wakey time

    Why did it cause the US financial system to collapse in 1929?
    Bankers get to create money out of nothing, through bank loans, and get to charge interest on it.
    What could possibly go wrong?
    Bankers do need to ensure the vast majority of that money gets paid back, and this is where they get into serious trouble.
    Banking requires prudent lending.

    If someone can’t repay a loan, they need to repossess that asset and sell it to recoup that money. If they use bank loans to inflate asset prices they get into a world of trouble when those asset prices collapse.
    As the real estate and stock market collapsed the banks became insolvent as their assets didn’t cover their liabilities.
    They could no longer repossess and sell those assets to cover the outstanding loans and they do need to get most of the money they lend out back again to balance their books.
    The banks become insolvent and collapsed, along with the US economy.

    Keep bank credit out of the markets.

    The UK used to be the great financial superpower and it looks as though we understood this in the past.

    What happened in 1979?
    The UK eliminated corset controls on banking in 1979, the banks invaded the mortgage market and this is where the problem starts.
    The transfer of existing assets, like real estate, doesn’t add to GDP, so debt rises faster than GDP until you get a financial crisis.

    Before 1980 – banks lending into the right places that result in GDP growth (business and industry, creating new products and services in the economy)
    Debt grows with GDP
    After 1980 – banks lending into the wrong places that don’t result in GDP growth (real estate and financial speculation)
    Debt rises faster than GDP
    2008 – Minsky Moment, the financial crisis where debt has over whelmed the economy
    After 2008 – Balance sheet recession and the economy struggles as debt repayments to banks destroy money. We are making the repayments on the debt we built up from 1980 – 2008.
    Japan has been like this since 1991.

    1. Sound of the Suburbs

      Keep bank credit out of the markets.

      The US trusted free markets in the 1920s, but by the 1930s, the free market thinkers at the University of Chicago were in the doghouse.
      The free market thinkers at the University of Chicago were just as keen as anyone else to find out what had gone wrong with their free market theories in the 1920s.
      In the 1930s, the University of Chicago realised it was the bank’s ability to create money that had upset their free market theories.
      The Chicago Plan was named after its strongest proponent, Henry Simons, from the University of Chicago.
      He wanted free markets in every other area, but Government created money.
      To get meaningful price signals from the markets they had to take away the bank’s ability to create money.

      Henry Simons was a founder member of the Chicago School of Economics and he had worked out what was wrong with his beliefs in free markets in the 1930s.
      Banks can inflate asset prices with the money they create from bank loans.
      Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
      “Simons envisioned banks that would have a choice of two types of holdings: long-term bonds and cash. Simultaneously, they would hold increased reserves, up to 100%. Simons saw this as beneficial in that its ultimate consequences would be the prevention of “bank-financed inflation of securities and real estate” through the leveraged creation of secondary forms of money.”
      Real estate lending was actually the biggest problem lending category leading to 1929.
      Richard Vague had noticed real estate lending balloon from 5 trillion to 10 trillion from 2001 – 2007 and went back to look at the data before 1929.

      Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
      “Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.
      This 1920’s neoclassical economist that believed in free markets knew this was a stable equilibrium. He became a laughing stock, but worked out where he had gone wrong.
      Banks can inflate asset prices with the money they create from bank loans, and he knew his belief in free markets was dependent on the Chicago Plan, as he had worked out the cause of his earlier mistake.
      Margin lending had inflated the US stock market to ridiculous levels.

      The IMF re-visited the Chicago plan after 2008.
      It looks like they do have some idea what the problem is.

      1. rob

        To think that banking is unique.. what other industry/profession allows one to create money from thin air… and then direct that money as an “investment”, in whatever the banker saw fit to grant the “owner” of that new money,a way to “pay it back”.
        The speculative bubbles it has caused.and is causing.
        the perversion of the whole idea of a “free market”
        the control of “the monied class”, who know their banker friends can keep writing loans… to get the old ones “paid back”.
        As has been quoted, if the people who work for a living and are forced to “live within their means” , realized those people they owe their money to…. could just make it up… and balance the books later…. were to understand the unfairness of this system…. they would be pissed. And “they” are most of everybody.

  8. Chauncey Gardiner

    Besides the FOMC, maybe this should also be addressed to the New York Fed. To paraphrase poet Elizabeth Barrett Browning in her Sonnet 43: “How do I love thee? Let me count the ways.”… Besides the strategies Edward Kane mentions here, there are issues of securities and control fraud, predatory lending, robosigning, asset stripping, markets manipulation, enabling and subsidizing speculative losses, debt leverage, net interest margins, off-balance sheet SPVs and SIVs that seem to return to the balance sheet in times of distress, accounting standards, negative real interest rates, financial repression, regulatory forbearances … and more.

    The key question is Why?… Is all this THAT important? And do we (and you) really want power to shift to the politicians under the Supreme Court’s “Citizens United” campaign finance system? As the real Supremes sang back in Motown: “Stop! In the name of Love… Before you break my heart… Think it over… Haven’t I been good to you?… Think it over… Haven’t I been sweet to you?”…

    To address the twin issues of regulatory decay and socially damaging behavior, I believe it is past time to restore the legal separation between speculative finance and the nation’s depository and payments system… Oh, and appoint Sheila Bair as Fed Chair.

  9. sierra7

    “Free market capitalism” and unlimited resource extraction is literally destroying the world we live in. You can make all the excuses and reasonings you want but this cannot be contradicted.
    Unless the world finds a better radical change in how we live our lives based on a more “natural” “friend of the Earth” way, we will perish with all our gold stuffed in our mouths.
    As many experts across the world continue to declare, we are very close to self destruction.
    Not surprising seeing how little we care about our environment and our “nest”.
    Forget who wrote about what was done with speculators some hundreds of years ago…..oh yeah, they were hung. End of story.

  10. rob

    how can people see so much wrong with the fed.. any examination on the historic actions of the fed shows how the fed is used as a tool of artificial control of markets… and with” citizens united “.. politics.
    Yet with the many propaganda platforms that are out there to fool the public into accepting the fed as “the government”…the people are told “there is nothing to be done” the fed is needed… to help the banking system… and the economy….
    these are scare tactics. Nothing is done about the boom -bust cycles it has created since it started.

    Really, the option is monetary reform. The fed is structured and works the way it does because the bankers made it up. The population of this country would be better off were the fed to be neutered and put in control of the people…. not the corporations.
    The law created by the federal reserve act MADE this fed… it will take an act of congress to create the money without debt. And this can be done. Wall street won’t like it… because it is a goose laying golden eggs for them.
    Among the propaganda platforms is MMT. This gets people to see we have a fiat money system, but still need the fed, and the debt, and all the input to the markets… to keep our little ship afloat.
    Since the thirties, there have been people working out alternatives… the chicago plan was the first attempt to end the privately controlled fed’s right to create money for private bankers who use that money to manipulate wall street fortunes. Now there are IMF working papers about “the new chicago plan” .
    The green party has a plank called “greening the dollar”… which is an attempt to address the failings of the monetary system we have now…i.e. the fed… /bankers creating money for themselves to use first… and letting the rest of the world rot.
    In 2011, a bill was proposed in congress by dennis kucinich, called “the NEED act”
    112th congress HR2990

    Now is the time to open to the idea of a national commission on monetary reform. Like hyman minsky called for.
    We need to look at the problem,, and get real as to possible solutions.
    And remember, the fed is the money spigot to all of wall street… and academia and the military and political actors; all will say anything to make sure that stream of money to them is never turned off.

    A single payer heathcare system, in a pandemic….
    Stimulus payments to “real people” , instead of zombie corporations and boon doggles…Which would buy us all time.
    a system to pay for all the things that SHOULD be happening…. COULD be an outcome of monetary reform…exposing the opaque “money power” who has control over our political and economic realities would also be “on the table”
    Not only is monetary reform a way to make better decisions as a population, but we can “cut-off” all those bad actors who run the show now.

    People need to focus their anger towards the machine….and cut them off at the knees… and when they are down… bust their heads wide open… for the vultures to clean up.

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