Bad Medicine

Last Thursday, the Federal Reserve announced that it would embark on a program to buy $40 billion of mortgage-backed securities every month until the economy improves, and hold interest rates near zero through mid-2015.

And how will that help the economy in general, and stagnating unemployment?  As near as I can tell, it won’t.

The point of buying ‘$40 billion of mortgaged-backed securities,’ of course, is that nobody knows how much they’re really worth, other than that it’s far less than $40 billion.  The intent is to make the banks whole from their bad investments of a few years back.

In a normal time, the banks might turn around and lend the money to consumers and businesses, encouraging demand, employment, and economic growth.  But they haven’t done that: they’ve found it preferable to simply sit on the money, and perhaps lend it to the government.

The other entities that might hold mortgage-backed securities probably have even less interest in lending to ordinary people and businesses.  In other words, the rich get richer, and all the rest of us get screwed.

If the money from the Fed’s quantitative easing efforts made it out into the general economy, the result would be massive inflation: the classic result of more money chasing the same goods.  But the reason we haven’t had runaway inflation so far is that the money has been kept out of the ordinary people’s economy.

So a fat lot of good it does us.

The beatings will continue until morale improves.

One thought on “Bad Medicine”

  1. Aggreggate demand for revolving credit loans has been declining for years, to be replaced with student loans.
    As banks are able to borrow at the discount window for close to 0% interest and lend it out on credit cards at 6-29.99%, they might have enough lent out to satisfy them because they are able to pass off their bad mortgages to the Fed. Don’t forget that they are also making 3% of every transaction on the credit card.

    Return OF principal is more important than return ON principal, particularly in a low interest rate environment. I would prefer to lend at a lower interest rate with total certainty of being paid both principal and interest than to have to chase a borrower to pay me back. I lack the temperament to run a payday loan store. However, if I am making enough loans at a high enough interest rate, I can afford to write off some loans and still be profitable. The bad loan writeoffs reduce my income, and if I give the borrower a Form 1009-C (miscellaneous income for forgiveness of debt), that money is income for them and is taxable at the state, federal and local levels.

    As a society, we forgot for a long time that the iron law of debt is that you have to pay back what you borrow, with interest. I question whether the number of qualified and WILLING borrowers is sufficient to soak up all the money that was pumped into the banks. We might want more stuff, but don’t want it at the cost of the loan that the banks would write. If we could borrow at 3% for 10 years for stuff, with fixed interest for the life of the loan, we might do it, but not at 10-20% on credit cards unless we must.

    A couple of years ago, minimum payments on credit cards were raised. This reduced the ability of “minimum payment” customers to use their credit cards, particularly as overlimit or late payment fees increased.

    We are having a huge amount of difficulty getting to the market-clearing price for credit, and that is why the money sits in the banks. We want to borrow at X%, but the banks want to lend at 3X%. Would it have been better if the government had required banks to lend at something like 200 basis points over the 30-year bond? I doubt it, because the creditworthiness of the average person in the U.S. has declined over the last 20 years.

    Banking should be simple. The old joke was that they gave you 3% on your passbook savings, lent it out at 6% with 20% down on the house, and they were out on the golf course by three. It’s when you stack the reinsurance on top of reinsurance policy and have credit default swaps that aren’t marked to market every day, forcing one who is losing money to post additional margin or close the position, that things get bad. The counterparty risk, which is the risk that the other person won’t pay off, is huge.

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