Reader Requests: Is the Fed Really That Stupid?

In response to my op-ed on the Federal Reserve, a reader says: You claim that banks are not lending due to non-creditworthiness of potential customers. I say they don’t lend because they really don’t have to anymore because the Fed pays them interest on their reserves. That translates to unprecedented interest spreads on the loans that they do fund, as well as unreasonably low interest rates paid to depositors, many of whom are retired and rely upon bank interest for much of their income. In addition, these super-size banks are holding onto bad mortgages and not refinancing them as they are supposed to do. They would rather foreclose or wait until the market gets better so they can make more money on them. Also, what about TARP, which was supposed to get these bad properties off the banks’ books in order to strengthen their capital financial strength? The banks kept the bad assets, and the Treasury gave them money to boot.

The Fed pays 0.25% interest on reserves. In a healthy economy, banks should have no trouble finding borrowers who will generate a higher return than 0.25%. As you said, borrowing at 0.25% from the Fed “translates to unprecedented interest spreads on the loans that they do fund.” That’s an incentive to make more loans, not fewer. The problem is finding creditworthy borrowers. Remember, banks don’t need to lend the excess reserves from the Fed if they find creditworthy borrowers. They can find cash elsewhere. Interest on excess reserves isn’t holding them back.

I completely agree with your second point, re bad mortgages, refinancing, and TARP. However, most of these problems don’t fall under the Fed’s purview. TARP was a terrible deal for taxpayers, but it was administered by the Treasury, not the Fed. It also falls outside the purview of my op-ed, which was supposed to address actions taken during the recovery, not the recession.   Continue reading “Reader Requests: Is the Fed Really That Stupid?”