April 23, 2012
The Fed Works for the Very Rich
WHY PAUL KRUGMAN IS FULL OF SHIT
Late last week Princeton University economist and New York Times
columnist Paul Krugman wrote a piece on his NY Times blog that history
will view as the best evidence to appear in at least several decades of
the utter irrelevance of mainstream economics. The piece purported to
respond to a Wall Street Journal editorial by Mark Spitznagel in which
Mr. Spitznagel argued broadly the Austrian economists’ line that all
government spending favors one group over another and more specifically
that the Fed’s Quantitative Easing (QE) programs of recent years favor
banks and the rich.
Mr. Krugman could have argued his New Keynesian shtick that
government investment can prevent deflationary spirals in economic
downturns and all would be as it was. Instead, he chose to argue (Plutocrats and Printing Presses – NYTimes.com),
an astonishing amount of evidence to the contrary, that Fed QE policies
have not disproportionately benefited banks and the very rich and were
in fact enacted against their wishes and interests.
The basis of his argument has two parts:
(1) conservative economists argue that QE is “printing money,” they also argue that printing money causes inflation, banks hate inflation (because loans get repaid in less valuable dollars), therefore banks opposed QE and
(2) that banks earn profits from the difference between long term interest rates and short term interest rates (NIM, or Net Interest Margin), QE has reduced this difference, therefore the banks have seen their profits fall from QE.
Were these arguments used when writing about a (1) solvent banking
system whose (2) profits still came from making prudent loans to
creditworthy borrowers and (3) whose shadow banking system was
immaterial (couldn’t destroy the global financial system), then Mr.
Krugman might have had a point. The facts, however, suggest that if bank
loans and other bank assets were fairly valued the big banks would be
conspicuously insolvent, that the entire impetus of banking
consolidation and deregulation (as explained by bankers) was to reduce
the impact of NIM on bank profits, and that building out the shadow
banking system was the way that banks intended to accomplish this.
The housing crisis that began in 2006 is well known to most people,
but it was part of a much larger build-up of debt by households and
corporations at the behest of bankers. Among the “innovative” home
mortgage types that put people who couldn’t afford regular loans into
houses were “adjustable-rate mortgages” (ARMs). What set off the initial
stages of the financial crisis was the realization that (1) a large
percentage of people who had taken out mortgages couldn’t repay them
under any circumstances and (2) if rising interest rates caused the
mortgage payments on ARMs to rise then a much larger group of people
would also default on their home mortgages. In 2007 – 2008 both of these
realizations caused the value of the mortgage loans held by banks
either directly or through securitizations (the banks’ own creations) to
fall precipitously.
The same principle that rising interest rates cause the market value
of loans and loan-type instruments to fall applied to an unprecedented
quantity of assets held by banks in 2008, and still does today. However,
the opposite is also true, when interest rates fall the market value of
loans on bank books and in financial markets rises. As too much
un-repayable private debt in the economy was what made the banks
insolvent, lowering both short and long term interest rates has had far
more impact on restoring the banks to faux health by raising asset
values than profits from interest margin (NIM) possibly could have. The
banks killed their ready supply of credit-worthy borrowers along with
the economy in the 2000s— the only game they could play was to restore
the market values of the garbage assets that they held. The Fed
willingly accommodated this strategy.
The Fed wasn’t alone in its efforts to save the banks at all costs–
the utterly corrupt actions by ex-New York Fed Chair, now Treasury
Secretary, Timothy Geithner, and current Fed Chair Ben Bernanke to move
bad loans made by the banks to other government agencies including FHA,
Fannie Mae, Freddie Mac and an astonishing array of seemingly unrelated
others, was tied to Fed asset purchases through QE. Readers may remember
the low interest, non-recourse government loans that were used to
induce hedge funds to buy garbage assets at no risk to themselves
(non-recourse) to (1) get the assets off of bank books and (2) to create
faux market prices for garbage assets based on contrived economics to
thereby induce less sophisticated buyers to pay higher prices for the
assets. The Fed itself bought assets at higher prices that it had driven
higher.
The way that the Fed’s QE directly benefited the very richest
Americans, in addition to the most recent vintage of richest Americans
being bankers, is by running up the value of all financial assets. Fed
Chair Bernanke gave a veiled explanation of how this works in his
Jackson Hole speech from 2010 that can be found online. Mr. Bernanke
calls his method the “portfolio balance channel,” and it it is premised
on two basic economic concepts, supply and demand and substitution. When
the Fed buys assets it takes those interest-paying assets out of
circulation and replaces them with cash. This reduces the supply of
interest bearing assets in financial markets and replaces them with cash
with which to buy other assets. It also reduces market interest rates
thereby making stocks and other assets (substitution) more attractive.
But we need not rely on theory to see if this works the way that Mr.
Bernanke theorized that it would. There are a significant number of
rigorous analyses that were done demonstrating that when the Fed (or the
ECB) is buying assets through QE financial markets rise and when the
Fed stops buying they fall. The evidence is both unambiguous and
voluminous. And in an anecdotal sense, there was some skepticism from
Wall Street in 2009 when QE began but few if any doubters remain—it is
absolutely the perceived wisdom on Wall Street that the reason that
financial asset prices have been rising when they have is because the
Fed is causing them to. The only question still out there for Wall
Street is whether or not the Fed will continue to run prices up further?
How does running up the prices of financial assets directly benefit
the richest Americans? Ironically, every three years the Fed also
produces a survey of income and wealth distribution in the U.S. that is
available on the Fed’s website. The data is broken out by income and
wealth deciles. The quick answer to who benefits from rising financial
asset prices is that the rich do because they own all the financial
assets. See for yourself on the Fed’s website.
So far the Fed has tried to save the banks by keeping interest rates
low and through various programs to dump toxic assets on the rest of us
and it has revived the fortunes of the kind folks who looted the banks
and stolen our wealth (the very rich) by running-up stock prices. The
Fed did this with QE1, QE1.5, QE2, QE2.5, “Operation Twist” and various
less publicized programs with similar intent. The banks and bankers have
absolutely loved these programs—read their research and you will see.
On his very own blog Mr. Krugman referenced UC Berkeley economist
Emmanuel Saez’s recent report stating that since the recession
theoretically ended in 2009, the top one percent of income earners has
received 93% of income gains. Mr. Saez’s research illustrates that it is
the revival of capital gains from rising financial asset prices
(including stock options granted to corrupt executives) that is behind
the gains.
Finally, Mr. Krugman claims that the only way that banks could have
benefited from the Fed buying assets was if the Fed overpaid for the
assets. Fed Chair Bernanke publicly stated at the time Fed purchases
commenced in 2009 that the Fed was going to overpay for the MBS
(Mortgage-Backed Securities) it purchased in order to induce banks to
sell them to the Fed. This was widely reported in the financial press at
the time. It was also widely viewed as part of the ongoing (never
ending) bank bailouts. Readers may recall the news reports from all of
the Wall Street banks of perfect trading records (banks earned profits
from trading financial assets every day) for several quarters in 2009.
If the banks are winning then someone else is losing—thank you Federal
Reserve. If Mr. Krugman can’t find credible contemporaneous reports of
this then he should try a little harder.
Last, there is no ax to grind here with Paul Krugman. Mr. Krugman
has put a human face on his politics for which he should be thanked. But
legitimate criticism of his economics includes the absence of the class
struggle that Wall Street and the Federal Reserve clearly understand as
evidenced by their actions—they are fighting for America’s rich and
their policies are intended to benefit them alone. The sleight of hand
that sustains mainstream economics is the claim that we all benefit if
the system benefits. Take a look around and you’ll see that no, we don’t
all benefit. In fact, were it not for the ideological drivel disguised
as mainstream academic research, this would be evident to even the least
interested among us. When in doubt, look a little harder.
Rob Urie is an artist and political economist in New York.
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