He is saying that proceeds overnight discount window loans are then used to buy 10-year (2%) or 30-year (3%) US Treasuries. This notion is creeping around lefty populist circles. I even heard Jon Stewart repeat it. The problem, of course, is that Fed discount window loans must be paid back in 24 hours making a 2% yield impossible from that source.
Does anyone want to defend Stiglitz’s position?
The Federal Reserve loans can be, and were, rolled over many times.
A one-day loan for 0% interest, whose funds are sunk into another investment, won’t earn a 2% over a single night. But if the loan is rolled over 365 times, it quite possibly will.
Even people who don’t know what the Fed is or what it does should question that statement.
He talks about borrowing money but doesn’t mention any terms about paying it back. And instead of paying it back, the borrowing bank turns it around and lends it to the Fed at a higher rate. Without any due dates or maturity dates, it’s like a fantasy about borrowing money without ever having to pay it back. Call it a rollover.
The difference between reserves and capital is also missing from what Stiglitz wrote. This misunderstanding about what the Fed does is something I’ve heard from end-the-Fed Ron Paul libertarian types.
That’s not what he wrote.
It’s not an easy excerpt to understand, since his primary focus is making a political point rather than explaining Fed lending procedures during the financial crisis. But the article describes things differently, and the gist of what he says (in this short segment) is correct.
The bank borrows money from the Fed (part of the government). Then the bank lends the money back to the government, but not back to the Fed as you claimed. The bank lends the money back to Treasury, in the form of buying government bonds. And he’s correct, this did happen. And he’s correct, this is an absurdly easy way to earn a spread. This was one of the more discreet methods for the government to slowly recapitalize shaky banks. It’s a nice racket if you can get it. But people say it was necessary.
It’s hard to know what your criticism is here. Stiglitz explicitly said that the loans were paid back. It’s not within the scope of the article to discuss every detail of the loans. His point is that the banks were given generous loans from one part of the government (the Fed), and then lent the money back to the government at a higher rate of interest. This was free profit for the banks. In order to prove how widespread this was, he’d have to provide more information. But again, that’s not the point of his article. His point is that it happened. And it did.
He left out other things that could’ve helped his argument, for instance, that a lot of the collateral for these loans was less than standard, by some measures up to 72 percent of this collateral was non-standard shortly after the collapse of Lehman. This was generous to the banks, but it would also take more explaining so he left that part out.
Also missing is the quality of the collateral used for the loans, which was often bad. Also missing is a list of all the facilities that the Fed had to lend to banks. This is not a sign that he misunderstands. It’s a political argument. He just doesn’t spend many of his words on the technicalities, including the technicalities that would strengthen his points.
I don’t generally agree with Stiglitz on monetary matters, but it’s worth being more careful about how to criticize this particular political article.
And now that I’ve read the article more carefully, I want to make a few more notes about the OP. The original assumption was that any bank that borrowed from the Fed would have to do so through the discount window, and that the discount window was exclusively overnight loans. Both these assumptions are not right. The discount window was originally overnight loans, but during the financial crisis, the Fed expanded the term of the loans to a month in order to make it more enticing for banks. But more than that, the discount window was not the only way to borrow from the central bank. There were other lending facilities created, including the Term Auction Facility, the Primary Dealer Credit Facility, the Term Securities Lending Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, and some others. Stiglitz did not in his article restrict his discussion to the discount window. He didn’t even mention the discount window. He talked about Fed lending in general, and there were many possible ways to borrow from the Fed outside the discount window. And as I said before, even relatively short-term loans from the Fed can be, and very often were, rolled over many times.
I’m tempted to say that when a Nobel-Prize-holding economist says something that sounds like nonsense to you, it is because you don’t understand it.
But, then, both Milton Friedman and Paul Krugman got Nobels and they disagree on practically everything, so who knows how much it really means.
Milton Friedman doesn’t disagree with Paul Krugman on anything anymore, being dead now for several years.
You see?! You see?! Those two can’t even agree on the value of breathing!
Liberal economists have incorporated much of Milton Friedman’s thinking into their POV.
Krugman, stating that he and Friedman are on one side of the argument, with Ron Paul on the other: Friedman and the Paleomonetarists - The New York Times
One of Brad DeLong’s fond articles on Milton Friedman, from 2007: http://www.democracyjournal.org/4/6514.php?page=all
Then again, back in 2007 I would have argued that disagreements between mainstream economists were overblown and that there actually existed a surprising amount of consensus. That view was torpedoed during the Lesser Depression.
OP
I agree that Stiglitz’s point makes economic sense. I tend to support the recapitalization of banks on the sly though. I just think that main street could have usefully received more support in the form of a larger infrastructure program. As it is, public construction as a share of GDP is lower now than when the Lesser Depression began. It’s lower governmental spending or austerity fever that’s holding the nation back.
Isn’t this the basic model of what banks do? Borrow at a low rate, lend at a higher one? The difference here is that they were borrowing from the Fed rather than depositors, but the rates that ordinary depositors would have been getting would not have been much above zero at this point anyway, right? And a 2% return on a T-bill is not nothing, particularly at the height of the recent bad times, but compared to the returns that a bank would have been getting if it had been able to make mortgages or car loans, that 2% presumably is more a matter of survival than any great success.
But in the long run, Krugman will agree with Friedman.
Then those loans would be on the Fed’s balance sheet I linked to. They are not. I know for a fact the CPFF was closed long ago and was for commercial paper alone (not banks).
I linked to the pertinent Fed report in the OP.
Aside from the tiny $30 million primary loan nothing much exists. Since the Fed publishes its balance sheet any volume of loans to banks that would allow billions in profit should be readily visible.
They are not.
Go back to 2010 and there are no loans to speak of.
You’re right. I have double checked all the various Fed temporary programs from the crisis and none allow long term loans.
And certainly any that would in turn allow a US Treasury investment yielding 2-3% is straight out impossible. The Fed even bumped its overnight rate up to .075%.
Lots of interesting points here.
The first basic response is to just look at what the government is doing (keeping in mind that the Fed is part of the government.) Imagine if a government official walks up to you and says, hey, would you like to borrow a million dollars at close to 0% from us, the government? Free money, as long as you don’t blow it. So you say yes. Then the next day another government official walks up to you and says, hey, the government needs to borrow a million dollars at 2%. Is that okay? And you say yes. You have to admit this is a little weird.
It’s even more problematic if you used to work with both government officials for several years, and you still play poker with them every Tuesday night. Borrow at zero and lend at two is banking, yes, but generally you’re not borrowing and lending identical amounts to exactly the same set of people, with essentially no risk to yourself. A nice racket.
Next, even if it were true that depositor rates weren’t too terribly higher at that point in time, that still doesn’t help. That well had already gone dry. Any excess cash in bank vaults had already been shuffled off into supersafe assets (ie Treasuries). Private banks can’t just increase new cash magically. Someone has to give it to them. To get cash from new deposits they’d have to raise the rate that they’re offering for those deposits… at a time when they’re already under stress. But new cash from the Fed? New cash straight from the printing press (so to speak) is like manna from heaven. It allows a new profitable “investment” with no work or risk on their part. Again, I’d be happy to be in that business myself. Make no mistake: this was flat out a gift to banks. “The loans were paid back!” I’m sure they were. But when can I personally get a similar loan under similar conditions? Oh I can’t because I’m not a giant bank? Our government was bestowing its largess to some of the largest financial institutions in the world, and at the same time they were arguably dithering on issues like mortgage bankruptcy relief for individual lenders.
The gifts might have been necessary, but we shouldn’t kid around about what it was: pure corporate handout.
One big thing that Stiglitz skips entirely which was also hugely important was the collateral the Fed accepted for many of those loans. I linked this before but it’s worth looking at again. If you go into the pawn shop with a thousand dollar diamond for collateral, then you can expect the broker to give you a loan for roughly a thousand bucks. If you go into the pawn shop with cubic zirconia, you should not expect the same size loan. But the Fed was taking the substandard collateral for full sized loans.
Why? Well probably because it also supported markets that were otherwise exploding. A sort of lender of last resort function. The very fact that there was a lender willing to hoover up these kinds of assets worked to prop up the value of those assets, and thus bank balance sheets. Again this was arguably necessary at the time. But we can still be disgusted at the system that made it necessary.
I have no idea what you’re trying to say here.
The balance sheet of the Fed was around 870 billion in August 2007. It was more than 2,000 billion by the end of 2008. Today it’s more than 4,000 billion. Obviously that was never all loans to banks. The Fed also bought Treasuries directly, and also took repaid loans from banks and reinvested that returned money in Treasury purchases (along with MBS purchases and federal agency debt). But there were also loans, and that was a lot of money. More than thirteen banks had in excess of 50 billion dollars of Fed loans outstanding at their peak of borrowing.
Initially the Fed wouldn’t reveal the information about who they were lending to, and in what amounts. This was a big deal. It was in the news. They felt the info would be harmful to markets. Eventually they had to acquiesce to a freedom of information request. That was also in the news.
Bloomberg quoted peak borrowing much higher. But that was then and this is now.
Have you looked at the link from the Fed I supplied? If Stiglitz is telling the truth why don’t the loans he claims exist show up on the Fed’s balance sheet information?
It is really a simple question.
Stiglitz is making a claim that cannot be supported using Fed data.
I haven’t combed through the bank’s balance sheets, but I did skim the Stiglitz article. His claims about what the Fed did were contained in one paragraph. I the previous paragraph Stiglitz writes, "The Obamians seem bewildered that the country is not more thankful to its government for having prevented another Great Depression. They saved the banks, and in doing so, they saved the economy from a once-in-a-hundred-year storm. "
The point being is that Stiglitz was talking about the measures taken by the Obama administration during the financial crisis and its aftermath. Other than QE3, I’m not entirely conversant with the details of the Fed’s current actions. But I don’t think Stiglitz was necessarily referring to that.
One aspect Stiglitz does not discuss but should have was that at the time bailouts of homeowners, incredibly enough, were less popular than bailouts of banksters. That after all was the source of the tea party rant taken on the floor of the Chicago merchantile exchange.
Yes, I have looked at your 2014 balance sheet. I’m not sure why you think a balance sheet today is relevant for talking about loans during the Lehman disaster.
The crisis starting pinching in 2007 and things went to shit in 2008. But most of the bank loans were repaid by the end of 2009. Look again at the Bloomberg interactive data site I already linked. Look at the dates. A few of the major banks were in debt to the Fed more than 600 days, but eyeballing a few of the monsters, I’d say the average was closer to 400 days. The loans were repaid by the end of Obama’s first year in the presidency. Your present-day balance sheet is not going to show that. The Fed took the repayments and plowed them into other assets like Treasuries.
Naturally, it’s going to look much different if you look up a January 2009 balance sheet.
Read Stiglitz again. He didn’t give dates. He blames Obama, sure, but in this case he’s blaming Obama for a policy that he inherited from Bush in his very first year in office. Maybe Obama could have done something different, but he didn’t. Obama continued Bush’s policies for that first year. (Or he let the Fed continue to do what they were doing, or whatever. It’s hard to say who made precisely which decision. Sometimes “Obama” is just the name we attach to the government after Jan 2009.)
…rereading his sentences, I’m wondering if this whole thing is because he shifts into present tense when he’s describing the mechanism. If that’s your issue, you should know he’s doing that because he’s describing a process, an idea. He left the historical narrative for a moment (where he was using past tense) and shifted into talking about the idea. And ideas always kind of exist right now in our minds. I will often do exactly the same thing. Ideas are eternal, and present tense draws us in.
But he’s talking about Obama in 2009. That’s why it’s past tense as he relates the historical narrative, until he gets to the point when he’s explaining the idea.
I prefer to think of it as in the long run we are all Keynesian.
OK, loans taken out and repaid in 2008-09 are off the balance sheet now - true. So those loans are now retired and and the proceeds could not have been used to buy US Treasuries (unless a borrower used other funds to pay the Fed loan off - net no difference).
So** today’s** balance sheet shows no amount of significant loans. We finally agree on that.
So the bottom line is this: Stiglitz is making a false claim when he says Fed loans are then used to buy US Treasuries for a 10-30 year maturity (2-3%).
This is not a pedantic point. If you go to a lefty website they are ginning up all types of hatred for Obama (who I support) for corrupt Fed practices and they cite Stiglitz for proof. “Hey, the banks are getting rich ripping us off”.
The fact is this - Stiglitz is wrong on this particular matter.
No, he is not making a false claim.
You can go out today and borrow money on your credit card. If you swing a really great deal, you might get a 0% rate for six months or one year. Let’s say you magically get a 1000 cash advance for 12 months at zero percent.
You can then buy a 10 year Treasury. Let’s say you buy one of them for a cool thousand. You sit on it for a year. If the coupon rate is 2%, then you should collect two coupon payments of 10 dollars each. At the end of the year, you can sell your 10-year Treasury (still worth about 1000) to someone else, then pay off your credit card balance before you get docked with interest. Easy-peasy. You borrowed 1000 dollars at zero interest. You held a 2% Treasury for one year. You collected two coupon payments of ten dollars, so twenty dollars total (2% of 1000). Then you liquidated the treasury and paid off your card. You made 2% of 1000 dollars, exactly as you expected, from a 10-year Treasury.
That’s what he’s talking about. There’s no law in the financial universe that dictates you have to hold onto a 10-year Treasury for an actual decade. You can hold it for one year, collect two coupon payments, then unload it at whatever the new price is. The market for Treasuries is the most liquid market in the world. You can buy and sell these things at any time you like.
This is essentially what the banks did. This is exactly what Stiglitz is talking about.
They got a free loan from uncle sugar, and they got a couple three coupon payments for the duration of the time they held their bonds. When the loans came due, they unloaded the securities, paid back the debt, and still had the shiny coin of those coupon payments ringing like Christmas bells in their pockets. Pretty simple. You’d have to look up actual amounts to get the numbers perfectly right, but the idea he’s trying to get across here isn’t all that tough.
Stiglitz often annoys me.
But he is not at all wrong about this.
You have really concocted an elaborate scenario to defend Stiglitz - without an ounce of proof.
So I am supposed to believe that in the greatest credit crisis of all time, with 90-day LIBOR at 5%, that banks that were also failing to meet their reserve requirements tapped the discount window to play credit-card type shenanigans to make .2% basis point profits?