Choosing the Rich Over the Poor (Updated)

The editors of the Washington Post urge the Federal Reserve Open Market Committee not to raise interest rates when it meets next week:

The United States has a stubborn inflation problem. Food, rent and transportation costs remain high, and many parts of the service economy aren’t cooling off. It’s worrisome. But there’s a larger concern right now: the stability of the financial system. The rapid downfalls of Silicon Valley Bank and Signature Bank have zapped confidence in critical parts of the banking sector and triggered concerns about what is next to rupture. The Federal Reserve should temporarily pause interest rate hikes on Wednesday to give the financial system time to adjust to the new reality.

Bank failures are scary. This is not a repeat of the 2008-2009 financial crisis. But people are shaken. Many are moving money out of small and midsize banks and into larger ones. It’s getting harder to get a loan as banks have little appetite for additional risk. Regional banks remain under pressure. First Republic Bank needed a $30 billion cash infusion. Overall, banks have borrowed $308 billion from the Fed, up from $5 billion a week ago. A crisis abroad at Credit Suisse only adds more jitters. As the Wall Street saying goes, “When the Fed tightens, something breaks.” The nation needs certainty that nothing else is at a breaking point.

What I believe is being lost is that the OMC has already been too timid in raising rates as the inflation numbers clearly show and that inflation is a tax that falls hardest on the poor. Let it be noted that the WaPo is taking sides here and it’s not taking the side of the poor.

What I think this highlights is that if there is any target for the use of artificial intelligence it should be the Federal Reserve. Its failure to scrutinize Silicon Valley Bank would not have happened but for human error as is the case with stress testing banks at 2% interest rates when the interest rate has risen over 4%.

Let’s consider a tally of things that should be done all of which will require an act of Congress:

  • Reimpose Glass-Steagall
  • Require the Federal Reserve to observe the Taylor Rule.
  • If all deposits are to be insured, let’s amend the law to reflect that and fees on the banks that correspond to that practice.

And we should pick one. Either the FOMC should stay the course or we should abandon the notion that the Federal Reserve can control inflation on the grounds that it’s politically impossible for it to do so.

Update

This morning on one of the talking heads programs the present chairman of the House Financial Services Committee sounded just the right notes. This matter may be a legal problem, a regulatory one, a bank mismanagement problem, corporate mismanagement, or all of the above and it’s the Congress’s job to determine what in the heck happened and make the necessary adjustments to laws and regulations.

2 comments… add one
  • TastyBits Link

    Since you referenced Glass-Steagall, I will add this here, but it is applicable to your Roku & SVB posts, today (03-19-2023).

    A bank is nothing more than a ledger, and the major requirements are that the ledger be balanced and the capital requirements be met. This is true for 1st National Bank on Main Street or Goldman Sachs on Wall Street.

    Again, investing is inherently risky, and there is no way to change that. Additionally, investing in riskier ventures is more profitable. NEWSFLASH: Grandma’s life savings and your McMansion mortgage ain’t very profitable.

    The reason for a bank to want Grandma’s life savings and your McMansion mortgage is to balance the ledger and meet capital requirements. Access to the Fed window is the only reason retail banking is attractive to an investment bank.

    From 1929 to 1933, retail banking went through waves of bank runs and subsequent collapses. During The Roaring 20’s, investment banks would lend to investors on margin, and they would balance their ledgers by borrowing from retail banks.

    Until 1929, this worked great, but when margin calls could not be met, the investment banks could not meet their obligations. This led to retail bank runs and subsequent collapses. Everything would get better for a few months or years, and rinse and repeat.

    (The Dust Bowl was an additional factor, but it was not the catalyst.)

    The Banking Act of 1933 was the result of Sen. Glass and Rep. Steagall. Unlike Sen. Dodd and Rep. Frank, Glass and Steagall hauled in the bankers, gave them immunity, and ordered them to talk.

    Glass and Steagall concluded that there was no way for commercial banks and investment banks to safely intermingle. They then crafted an act to prevent retail banks from collapsing, but they also allowed investment banks to take risks.

    The FDIC and FSLIC were created to ensure retail investors that they could safely deposit money, but member banks were not allowed to engage in risky investing. When @Drew was a bank officer, he could not sign-off on the investments he makes today.

    (I hate bringing it up, but it is relevant. Sub-prime lending is profitable, but it is risky. Savings & Loans and commercial banks could not do much sub-prime lending because it would skew their risk profile. @Drew can add the technical language, but we all saw the result of not heeding G-S.)

    Until 1998, retail banking was mostly safe, and uninsured deposits were almost as secure as insured deposits. Because of this, there were few bank runs. For retail banking customers, the FDIC and FSLIC were more important than G-S, but retail banks were safe because G-S prohibited them from operating as investment banks.

    (Everybody wants to be as profitable as possible. Very few people ask to have their pay decreased. Bankers are no different.)

    Also, banks are not like other companies. Banks create money through lending, and when those loans are paid off, paid down, or written off, money is destroyed. Furthermore, M2 is the maximum amount of base dollars that exist, and if all risk intolerant uninsured depositors & CD holders removed their money, the financial system would collapse.

    (At most, I consider M1 to be base money, but much of that was still created on ledgers.)

    The modern financial system is a gigantic inflated balloon held together by interconnected balance sheets. Pricking a balloon does not just destroy that tiny area.

  • Drew Link

    “NEWSFLASH: Grandma’s life savings and your McMansion mortgage ain’t very profitable.”

    But remember, return in assets is not return in equity. The inherent leverage in the reserves structure of a bank make these lending businesses profitable.

    “When @Drew was a bank officer, he could not sign-off on the investments he makes today.”

    LOL. Exactly. Which is why I keep making the point. Was SVB making “loans,” or making risk asset investments. A pox on management, but also the vaunted regulators.

    You know, the uninformed can cluck click about things. Regional bankers may know their community, but they are not the brightest bulbs. You don’t want regional bankers engaged in modern banking of scale. That doesn’t mean you always get sophisticated or honest people at big banks. See: SVB. But please hear me; regionals only is not the answer. We run into this all the time when we acquire. The owner tells to call good old Ed at his local bank. Well. Good old Ed is clueless when we start talking LBO loan to him.

    As an editorial comment as well. How many people understand that a home mortgage is a little, personal LBO? 20% (or less) equity. Our LBOs are capitalized 35-50% equity. Who knew John Q Public were wild eyed speculators? And yet home ownership is revered. So much so that Barney Frank and Maxine Waters couldn’t get it through their thick heads that 5% -10% down in the name of “the dream of home ownership” was destined to fail. Neither could a certain doctor get it through his thick, partisan driven head.

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