High-Powered Idiocy from Academic Wonderland; Three Reasons Banks Not Lending; Blinder is Blind

By: Mike Shedlock | Wed, Dec 11, 2013
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Alan Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is back at it.

In an Op-Ed in the Wall Street Journal Blinders says "Don't only drop the interest rate paid on banks' excess reserves, charge them."

Please consider The Fed Plan to Revive High-Powered Money.

Unless you are part of the tiny portion of humanity that dotes on every utterance of the Federal Open Market Committee, you probably missed an important statement regarding the arcane world of "excess reserves" buried deep in the minutes of its Oct. 29-30 policy meeting. It reads: "[M]ost participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage."

As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative, I can assure you that those buried words were momentous. The Fed is famously given to understatement. So when it says that "most" members of its policy committee think a change "could be worth considering," that's almost like saying they love the idea. That's news because they haven't loved it before.

Not long ago--say, until Lehman Brothers failed in September 2008--banks held virtually no excess reserves because idle cash earned them nothing. But today they hold a whopping $2.5 trillion in excess reserves, on which the Fed pays them an interest rate of 25 basis points--for an annual total of about $6.25 billion. That 25 basis points, what the Fed calls the IOER (interest on excess reserves), is the issue.

Unlike the Fed's main policy tool, the federal-funds rate, the IOER is not market-determined. It's completely controlled by the Fed. So instead of paying banks to hold all those excess reserves, it could charge banks a small fee, i.e., a negative interest rate, for the privilege.

At this point, you're probably thinking: "Wait. If the Fed charged banks rather than paid them, wouldn't bankers shun excess reserves?"

If the Fed turned the IOER negative, banks would hold fewer excess reserves, maybe a lot fewer. They'd find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want.


Initial Thoughts

For starters, my first thought was not "Wait. If the Fed charged banks rather than paid them, wouldn't bankers shun excess reserves?"

Banks are not holding excess reserves because the Fed pays them 0.25% interest annually. Banks are holding excess reserves in spite of the fact the Fed pays them 0.25% interest annually!

The difference is huge. And the three-fold reason is simple.


Three Reasons Banks Not Lending

  1. Banks do not have credit-worthy customers.
  2. Credit-worthy customers do not want to borrow.
  3. Banks are capital impaired.

Is number 3 that unbelievable?

I think not. Banks still do not have to mark assets to market. What are they hiding?

Even if one assumes banks are not capital impaired, reasons 1 and 2 are sufficient enough to explain why banks are not lending.


Are Corporations Starved for Cash?

National Federation of Independent Business (NFIB) surveys businesses each month to see what their main issues are.

Loans are never high on the list. Here is the NFIB November 2013 report.

NFIB chief economist Bill Dunkelberg explains ... "The year is not ending on a high note in the small-business sector of the economy. The 'bifurcation' continues with the stock market hitting record high levels, but the small-business sector is showing little growth beyond that driven by population growth. There is also a hint that employers are getting an inkling of what Obamacare might mean for labor costs, concern about the cost and availability of insurance bumped up 3 percentage points after a long period of no real change. Small-business owners who provide health insurance may soon find that their plans 'unacceptable' to Obamacare and be obliged to either pay more for the coverage or abandon it and pay the benefit in cash. This will be a major source of angst and uncertainty in 2014."


Most Important Issues Facing Small Businesses

Most Important Issues Facing Small Businesses

22% of small businesses complain about government red tape (which I presume includes Obamacare), 21% complain about taxes, and 15% complain about poor sales.

Only 2% of small businesses complain about financing.

Large corporations are flush with cash (debt really). They don't want or need to borrow either (but they are happy to keep rolling over debts at lower-and-lower interest rates).


Blinder is Blind

Those in academic wonderland are too blind to see what should be perfectly obvious: Banks would not accept a paltry 0.25% if they thought they had creditworthy customers willing to borrow.

And although creditworthy customers don't want to borrow, Blinder wants the Fed to force banks to lend anyway! To Whom? Banks can only do so by lending to non-creditworthy customers. How would that work out?

Let's step back and ask a simple question: Why are there excess reserves?

The simple answer: The Fed is printing money banks don't want or can't lend because banks are capital constrained or lack of creditworthy borrowers.

I am 100% in favor of not paying interest on alleged excess reserves but not for reasons stated by Blinder. Rather, I am in favor of unwinding every bit of QE madness that created the excess reserves in the first place.


Clear Signal

That Blinder wants to pay negative interest rates on excess reserves ought to send a signal to Blinder and others the Fed's QE policy was a failure (assuming one believes the Fed's stated reason for QE was to spur borrowing and job growth).

I believe the real reason for paying interest on reserves was a backdoor way of recapitalizing banks slowly over time. Regardless, the primary result of QE was the creation of bubbles in stocks and equities.

It's time to end the monetary madness, not double down on it with extremely ill-conceived and poorly-written notions of forcing banks to lend.

 


 

Mike Shedlock

Author: Mike Shedlock

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Mike Shedlock

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.

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