The New York Times explains a point that has been clear to industry insiders for a very long time but is mostly lost on others. The issue concerns: why does banking seem to be broken? The answer has to do with the ridiculously low interest rates. Banks are drowning in cash – tending toward 100% reserve by default.
Today, banks are paying savers almost nothing for their deposits. As it turns out, the banks are not minting money on those piles of cash. Lending levels have not bounced back from only a few years ago and the loans going out are not keeping pace with the deposits rushing in.
What’s more, the profitability of each new loan has shrunk. Because the Federal Reserve effectively sets the floor off which banks price their lending rates, its decision to lower interest rates to near zero means the banks earn less money on the deposits they lend out.
The banks are also earning less on the deposits left over to invest. They typically park that money overnight at the Fed for a pittance, or invest it in ultra-safe securities, like bonds backed by the government. But with interest rates so low, the yields on those investments have been crushed.
The article also quotes bankers who dream of the day when the economy improves and they can crank out the new money through the credit system. That’s the scary part.
What I don’t get is why the Fed thinks that maintaining 0% interest is going to spur economic activity.
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It doesn’t spur economic activity; it props up the housing bubble, which is the real policy goal.
YES! Why? Because if the economy deflates to fast the people will catch on. The goal is to transfer the rest of US assets to to top 1% and then the BIG crash will come. A cash economy for us serfs will no longer be a necesssary tool for the 1%.
The Fed is now paying interest on reserves, a very clever and sneaky way to recapitalize the banks.
That means they’re minting money for practically no risk, doesn’t it?
You can’t have it both ways. People here are constantly claiming that overly low interest rates caused the housing boom and the subsequent bust by encouraging lending too much. If low interest rates encourage lending they encourage lending.
My understanding is that low interest rates *encourage* lending, because the banks think they are more likely to make money on investments and loans than on parking them in “safe assets” like bonds, or just holding them in reserve. That banks are investing in safe-assets instead of making loans reflects reduced demand for loans (because people are already over-leveraged, and because business conditions are so bad that few investments look like they are worth making), and fear that riskier assets are likely to be bad bets in the economic climate.
Right now reserves, and many government bonds, have expected real negative yields. In that climate, any investment likely to have a return higher than inflation is a good investment. If the economy was better, expected ROI would improve and the floor interest rate could rise without reducing investment. Increasing returns on government bonds would only discourage bank lending further. I don’t understand why this is complicated. I see this precise line of reasoning here all the time when talking about how bubbles form.
No one is trying to have it both ways. The point is that the Fed and the banks are always wrong, because they have destroyed the interest rate price signals. They overlend and underlend, and can’t tell one from the other. They have no feedback to guide them.
It’s like trying to navigate around the world with a broken compass, no map and no stars. Even if you end up going in the right direction once in a while, which almost never happens, its an accident.
The Fed’s decision to pay interest on reserves is one of the worst aspects of this depression. Banks are under an affirmative legal duty to make money for their shareholders. They can’t sit around and do nothing, even if doing nothing is economically the best option. The people who run them are obligated to go out and find the best place for their money.
When defaults are everywhere, and a retail bank can get a 0.25% return from the Fed for parking its reserves there, that’s better than lending money to a business where the return could very well be less than zero (i.e., a true loss).
The Fed is the black hole of money. Parking money there means it doesn’t exist. This decision to pay interest on reserves sucked a trillion dollars out of the economy almost overnight.
So, these bastards have managed to set up a system where everyone is forced to rely on the Fed and banks to lend and lend and lend, in order to create the money we are forced to use, but when there’s risk to the bankers’ precious bottom line, they turn off the tap.
Of course, over-lending is the other aspect of the problem. There’s no real way for the banks to guess the correct amount of lending. Neither the Fed nor the banks have the necessary information to know what the economically appropriate rate of lending is. There’ s no real interest rate market to supply that information.
It’s interesting how many articles can have correct analysis and still come to the completely wrong conclusions.
A quick look at real-world interest rates reveals that they are many times what the Fed charges the banks.
Another quick look at the Fed funds rate and mortgage interest rate shows nearly no correlation. FFR dropped to near 0 in December of 2008 and has stayed there ever since. Mortgage interest rates have swung up and down by more than a full point.
I don’t see any evidence that the Fed is setting an interest-rate floor for any loans except for the ones that it originates.
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