Even When I Thought it Was Stimulation, I Knew it Was the Banks All Along


Arnold Kling tries to explain recent Fed policy actions re: injecting reserves into the economy and simultaneously paying banks interest on reserves to high school students, and comes to a sobering conclusion:

In spite of all the sophisticated rhetoric about "quantitative easing" and "new tools for monetary policy," the only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy. If your goal were to stimulate the economy, you would inject enough reserves to do that and not pay interest on reserves. That might require buying some long-term bonds or mortgage securities, but not the hundreds of billions that the Fed actually bought.

Everything the Fed has been doing over the past fifteen months makes sense if you think of their goal as transferring wealth from taxpayers to banks. If you try to explain it as an attempt to implement an expansionary monetary policy, you won't even get past my high school students.

My November Reason magazine feature on the new political war against the Federal Reserve.

NEXT: Are Americans Really Saving More?

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. The goal is simple: You continue pouring money into The Financial System, without encouraging The Financial System to lend to anybody except in politically convenient circumstances (such as keeping bad borrowers in their homes) in which losses are paid for by taxpayers. Then when The Financial System has been preserved, it will theoretically start lending again.

    You just need to keep the following principle in mind: Pump in enough embalming fluid, eventually the corpse will leak.

    1. If that’s the case why the shift to smaller community banks and the recent push to get smaller banks to lend by offering them funds, which of course, come with strings.

    2. We’re going to stimulate the economy a new ass hole.

  2. I think it’s the result of the administration’s economists realizing that for every problem fixed by expanding or contracting the money supply a different one is exacerbated, so now’s the time to get on the good side of firms in the private sector they’d like to work for.

  3. The interest on reserves are just a narrowing of control of the fed fund rate. The ceiling is the discount rate and there was never a bottom, the rate could go to zero, of course no one would lend at zero. The interest on reserves acts as the floor. No one is going to lend for less than the risk free rate which is the interest paid on reserves. It is nothing more than another control for the FOMC. They billed it as several things, but none of them hold water.

    The entire thing was about saving a few people, Goldman Sachs, and as soon as that was done the next crew are turning into a control grab.

    1. I was just reading an article in the WSJ where Fannie was trying to unload its “tax credits” to GS. Fortunately, it was blocked by the Treasury. They must be having a change of heart.(?)


      What a fucking joke. If Fannie needs money, they can get it from the Treasury. They don’t need GS as a “middle man”. You were right, “Evil Geniuses”.

      1. I read the same thing. I spent a little time trying to figure out where GS would gain from it.(I’m not familiar with tax credits) I know the price being paid was a wash compared to the taxes owed. So I couldn’t figure out if it was the time between purchase and sale or what was the reason for them wanting the deal.

        I need to pay more attention and figure out the mechanism. Rent seeking firms are going to be a growth sector in the future. Hell they are now.

        1. GS would basically get a tax break for giving Fannie Mae cash. I imagine GS wouldn’t be paying “face value” for the credits.

          The tax credits FM had were non-refundable or wastable. Meaning, they couldn’t use them unless the taxes owed were equal to or more than the credits before they expire. FM would have to write down any unusable tax credits as a loss. So, if FM sold those unused tax credits to a firm that has a taxable income, the taxpayer would be on the hook for those credits and FM would not have as much of a loss. But I never knew that tax credits were transferable.

  4. Let the stimulators pay the stimulus tax. I pay the homer tax.

    1. That’s the home-OWNER tax.

      1. Well anyway, I’m still outraged.

  5. Our military understands they have been deceived.
    Whistle-blowers and leaks will not be blacklisted.
    Loud chicken-hawks hide behind the troops.
    News blackout while lies are fabricated.

    Wall Street & not-Federal no-Reserve.
    Israel-first dual-national AIPAC.
    Mossad media megaphone.
    Official 9/11 propaganda.
    Anthrax intimidation.
    Stealth cia neocons

  6. Wow, amazing those banks just do not know when to quit!


  7. Isnt it amazing, those bbanks just dont know when to quit!


  8. How about this one: We destroy the american poor with expansionary, inflationist policy (in the name of promoting what turns out to be unsustainable growth) and give them crumbs in the form of social services and entitlements, as a justification for further spending and monetary expansion. The system works! And only marginally less evil than using the monetary system for the military industrial complex.

  9. Here is the main question everyone should be asking themselves: Where are the banks getting all their profits? If you can answer that you should be able to make a million.

    1. I think most of us know how its done.

      unfortunately, we all can’t borrow from the Fed window (at zero interest) and redeposit it (or buy T-Bills) and pocket the spread.

      1. Ding! Hellp, you’ve hit the nail more squarely than Arnold Kling!

  10. Cavanaugh is correct that the point is to direct credit in politically convenient ways. He is wrong about the pumping it in and then it will leak out somewhere.

    The alternative approch of not paying interet on reserves, or even charging banks to hold reserves, will result in the banks “lending” the funds out as they see best. The result could be even lower interest rates on low risk loans. Perhaps the most obvious would be short term government bonds–T-bills. More of them with interest rates close to zero. But interest rates on loans to large corporations or maybe interest rates to homeowners who still have a good amount of equity in their homes are possible.

    The Fed instead has a policy of directing the credit to where they think it is needed. Much of the last year, the idea has been for banks to make risky loans, sell them to securitizers, and then have someone hold the securitized loans. Reviving the mouribund securitization market.

    It is a policy I have opposes. I favor letting the banks make the loans they think best.

    1. How does offering interest on reserves lower target rates? Before there was interest there was no floor on the fed funds rate, the ceiling was the discount window rate since at that rate (discount rate) the fed will offer any amount of funds to a qualifying bank. The interest on reserves does the exact opposite. No bank holding reserves will loan money at a rate lower than they can get from the fed. None of that is really capable of directing loans anywhere. The people pushing the directions of loans are the regulators at the fed, FDIC, OCC, Treasury (wtf not a regulator). The FOMC folks can’t influence where, they influence how or how much. The regulators influence the where and who along with congress.

      The mass amounts of money were used to try and get the commercial paper market moving again. That was the theory. The market froze, no one trusted each other enough to engage in unsecured lending. Their solution was to generate so much in reserves that there was zero risk of lending commercial paper. So the corpse analogy is some what accurate if you look at the first intent of the stimulus. Keep pumping until the opportunity cost of holding the money is greater than the risk of lending commercial paper.

      Obama and his crew tried to apply the same theory to lending in general. The problem is the commercial paper market is vastly different than commercial bank loans. The funny part is that abusing and making assumptions on models is what got the banks into the mess, and now the government is making assumptions about models and stretching their use to push stimulus. No really the first failure of doing this was just a fluke, it’ll work this time.

  11. the only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy.

    I don’t even think its about that. I’m beginning to believe its all about maintaining the US’s dominance in the World economy. Being second really sucks.

    1. What’s that giant sucking sound?

  12. The negative thing that Bush will be remember for is not Iraq or Katrina it will be TARP. Some real no shit powerful people were about to go broke. So they looted the treasury to make sure that didn’t happen. That was all it was.

    What was really sad, but not surprising, was how stupid the media and the pundits were. They convinced themselves and the world that this was the right thing to do and not just a bunch of bankers looting the government. And it wasn’t just talking heads. It was people who are supposed to have known better. I remember last fall on Megan McArdle’s site. I was posting about how I didn’t see why the government had to buy bad assets. I said they could just let the banks die and then loan out or print cheap money to the surivving ones to stimulate the economy. I never understood how buying worthless assets was the way to stop deflation and increase the money supply.

    I was then informed by Ms. McArdle that the professionals knew what they were doing and only unserious populists could possibly object to TARP. At that point, espeically after McArdle discovered that bailouts were bad when it related to the auto industry, as opposed to her friends in the banking industry, that stopped reading anything that idiot had to say. She is actually more of a fraud than her boy friend Sudarman.

    1. Ah-HAA! McArdle is the linchpin of it all!

      1. No just an annoying stooge cheerleading the looting of our country.

  13. The toxic asset buy was another example of a previously successful model being stretched to fit a new problem. They were trying to build another RTC, which actually worked. The problem is a nth CDO is damn near impossible to rate when it is predicated on a cash flow that is removed nth times from the derivative. Especially when that cash flow is derived from an asset that is part of a speculation bubble. The RTC basically bought property, not derivatives.

    In other news Obama echoed the “more people in their own home” line at his Ft. Hood speech. That policy worked out so well before.

    1. The RTC took over banks and sold the assets. But, as you point out, those were assets like homes and oil rigs and the like. This was just paper that no one knew how to value. Remember all the bullshit about how the government was going to make money on this? You don’t hear that claim much anymore do you?

      1. I never believed they were going to make money. The derivatives were so far removed from the cash flows there was no way to assess their risk. Which leads to one of the reasons companies are now issuing debt without Moody and S&Pe;.

        For the record the RTC did not take over banks. The FDIC did. The RTC was set up as an independent entity to receive the assets of liquidated S&Ls;. The Assets being collateral used to secure loans(property) and loans.

        1. Just for the record, since the MtoM rules were “modified” and the fed pumped all of the money into the banks, very few big banks have actually sold their “toxic” securities … in fact, talk is that some of them have been actually buying.

          1. The shifted some to the fed, but your right they still sit on the balance sheet, or off. I haven’t heard anything legitimate about them buying. Heard a few tinfoil rumors, but that’s it.

  14. Remember all the bullshit about how the government was going to make money on this?

    I thought I understood the expression “to make money”. Now I’m not so sure. 8-(

  15. Off topic:
    Barney Frank was present when his boyfriend was arrested for pot. He was surprised and disappointed with what police found. Now here is the unbelievable part. He said he wouldn’t recognize a marijuana plant if he saw one because he is not a “great outdoorsman” and “wouldn’t recognize most plants.” I would say 95% of U.S. citizens born since the 1950’s would recognize a pot plant if they saw one even if they had never been outside a city in their life. So I wouldn’t believe him even if he weren’t a politician.

    I got this from Instapundit, sorry for any html mistakes,…..juana-bust

    1. You mean Bawny lied?

      1. When I saw Barney blatantly–and I mean holy-shit-blatantly–lie to Jon Stewart on the Daily Show about his role in pushing the home ownership craze, I knew that Barney would have some more whoppers coming down the line. His lies are actually insulting to the person(s) he’s addressing. Stewart got a little flustered, because even he couldn’t believe Barney was lying that baldly.

  16. As John Houseman used to say, “We make money the old fashioned way. We mint it.”

  17. I am so lost on the details of this. Glad the rest of you are here to educate me.

  18. What does it mean to “inject reserves” into banks? What are the practical actions that do that, and why would the Fed pay interest on something it was “putting into” the banks?

    1. Oh god, explaining monetary theory on a message board would be rough.

      Think of reserves as two parts, the amount required and the excess over that. The excess us used to generate income with assets like loans to people and securities. The fed funds rate (rate banks lend to each other over night to ensure they have enough reserves, and subsequently all other rates is a target rate manipulated through buying and selling treasury securities to banks. Sell securities and the money supply shrinks making the cost to borrow money go up (rates up). Buy securities from banks and the money supply goes up causing the cost to borrow money to go down (rates drop). The Fed has so much data and has been doing this for so long it can manipulate the fed funds rate (which has implications relative to all other rates) down to a tenth of a percent or smaller. The injection is essentially bypassing the entire system and buying preferred shares of equity in banks. Basically the bank prints up stock certificates gives them to the Fed and the fed says ok you know have 4 billion more dollars in reserve. The 4 billion is just a number, on paper, generated out of thin fucking air. Now, if the bank has to hold 3 billion in reserves to cover its required 8% rate on deposits the bank has 1 billion extra to loan out. Since money sitting in reserve generally never earned interest, and now a low interest, the bank had an incentive to take the money sitting there earning no money and lend it, so they could earn interest on the excess reserve money. Hope that makes some sense. It’s more complicated in theory, in practice, and mathematically or model wise, but that is a down and dirty version.

      The interest on reserves for TARP funds is a good question and I have asked it myself, I’ve just been to lazy of busy to find out. The primary goal of starting to pay interest on reserve accounts was more than likely to create a floor for the fed funds rate and increase control.

      1. Look up things like:
        monetary policy
        Federal Open Market Committee
        Open Market Operations
        Fed Funds

        That would be a good start on getting a grasp on the central banking process in the US. The tricky part is to realize that in the end it is all just a number on paper and the money is essentially made up out of thin air. (which can be a bit scary)

        1. You mean on a computer. The process is so much faster now than it was 50 years ago when people actually had to write things down and send them out and wait for replies…

          Seriously, how many people actually physically, balance their checkbooks anymore? When I first started my business, my Grandmother, who was a bookkeeper, gave me a ledger for disbursements and receipts. I said, “what the fuck is this? I have Quickbooks”.

          1. Since a lot of the actual funds never really exist, it’s easier to just say they exist on paper. At least it makes it easier to teach or explain. But ya it is all computerized, which is scarier.

            1. Back in ’91 when went back to college, I took a lot of heavy science, math and engineering classes. Every calculation, no matter how small, I did on a calculator. To this day, I can’t do simple math in my head. It’s what I call “calculator lazy”. I think many people, firms, businesses, have become “computer lazy”.

              1. economics classes will solve that. I increased my ability to manipulate models and fraction in my head because of the functions and the graphic representations used in economics. Calculators were pretty much useless.

                The largest problem people have with understanding models is the inability to do simple calculus and math in their head or even on paper. Removing the graphic steps from the equation eliminates the largest asset in understanding models explaining situations.

                1. I should add I’m a little torn on the math subject with respect to economics. The academic programs for economics have become nothing more than shitty math programs. The concept of models and being able to manipulate models that reflect real life situations is being lost rapidly. IT seems like business schools and economics schools are switching with each other for the worse, business lost its math and economics has decided that’s all that matters.

                  1. “shitty math programs”

                    I remember I took a CAD class. Don’t forget, this was 91 or 92. They were using 486 computers running on DOS 3.01. Halfway through the class I realized that I wasn’t learning anything about drafting, it was just another shitty computer class. It may as well have been FORTRAN 77.

        2. She said, “What the fuck is Quickbooks?”

    2. To hmm,

      Thanks. You added something that I hadn’t come across. That “injecting” reserves is the same as buying stock (of a special class) in the bank.

      Of course, this investment would add to the useable reserves of the bank, at no interest.

      It remains a puzzle why the Fed would pay interest on the “reserves” of a bank. That is, on the part of investment and deposits in the bank that has not been loaned out. Why would that even be legal? Can the Fed just decide to pay companies for this and that?

      I assume for the moment that this purchase of bank shares is a voluntary transaction by the bank. The Fed offers to buy shares, and the bank has no business reason to refuse more capital.

      More questions.
      () Does the Fed have the right to withdraw its investment at any time?
      () Can it force the bank to buy back its shares and lower its invested capital?
      () Is that the Fed’s mechanism for withdrawing the reserves that it previously injected?
      () What if the bank has loaned up to its reserve requirements by the time the Fed decides to reverse policy?

      1. No clue on the legality. I have come to the conclusion that legality at the federal level has the consistence of pudding and forms whatever shape those in power want.

        The fed buying stock and flat out injecting money is unprecedented. The questions you are asking are the exact thing a room full of 30ish year old Fed slave economists are hammering out in a cramped room in DC. The fast and loose policy and way this was done has lead to a huge mess that no one really knows how to clean up. Every question you asked is spot on and a damn good question. You can probably take comfort in knowing a bunch of guys with PhDs can’t answer those questions, and it took them 9 months to even come up with the questions.

        One interesting salvation is that banks aren’t lending. The money they have in reserve is still in reserves. If a significant portion of that injected money leaves the banks the real multiplier is on and it’s game over. Inflation time. Massive hikes in rates ala Volcker style, and a really shitty time.

        Again great questions, wish I had some answers. Hell I wish we all had some answers, right now we are at the mercy of a small group of people who more than likely have had four jobs their entire life, fry cook, teachers assistant, professor, civil servant.

        The normal way the Fed works is to buy and sell securities voluntarily to banks to increase or decrease reserves. That system is currently out the window. We’re using the force at the moment.

        The reason for interest rates on reserves requires an understanding of the supply and demand curves for reserves. So I give you completely awesome faux MSpaint (mac) mad skillz.…..rketop.jpg
        -Federal fund rate is the y axis
        -Reserves held is the x axis
        -The demand is for reserves falls to the point at where interest is paid, you won’t loan below that since you can get that % guaranteed (floor)
        -The supply is the right angle in all three colors. It rises to the point at which the fed will lend itself to any good bank for any amount. (ceiling)
        -The discount rate is the rate the fed will loan to any amount of money to any “good” bank.
        -The current rate is the target rate or the starting point.
        -The blue line is the shift from the fed buying securities from banks and increasing reserves in banks.
        -The red line is the fed selling securities and decreasing the reserves in the banks.

        As reserves go up money costs less to borrow for everyone from banks to you and I, as reserves go down it costs more for everyone to borrow money (interest rates being the price to borrow money).

        Those are the extremes for supply and demand curves and the very very very simple example. But it might help understand exactly how the fed influences rates in normal open market operations. Note how the interest rates just recently employed create a floor that banks will never go below when it comes to lending to other banks.

        It should be noted, in case you don’t know. Fed funds are loans between banks of excess reserves they currently have with the federal reserve. The fed is not directly involved in fed funds, it is a bank to bank transaction. (not meant as an insult to intelligence, just a lot of people confuse the hell out of this)

        Now take that model, set it on fire, and throw it out a window. That is where we are at today.

        I totally agree with that article.

        The money multiplier equation he talks about is (fuck another picture)…..ger/MS.png
        c = currency the public is holding
        r = rate of reserve banks required to hold
        e = rate of excess reserves banks want to hold
        MB = Monetary base (aggregate of bank reserves and money held by the public)
        The interest paid on reserves both keeps money in reserves and the more important part, provides a lower limit the fed has absolute control over. In theory the fed can manage interest rates precisely and without using open market operations with a floor and ceiling on the fed funds rate. It was about control. Plain and simple.

        Epic long post, lots of errors, probably incoherent, sorry. At least there are things that look like paragraphs and it has PICTURES!!!

        1. In the first image the straight horizontal lines at the discount rate and the interest paid on reserves rate are the floor and ceiling within which the fed can force fed fund rates. In theory as the gap narrows the fed can make the fed fund rate any thing it wants without relying on open market operations, absolute control.

        2. To hmm,

          Thank you for the information and the graphs. I understand quite a bit more now.

          The policies which are hardest to understand are the ones that don’t make sense.

    3. Thoughts on the Macro Paradigm
      11/07/09 – EconLog – Arnold Kling

      Arnold Kling suggests the Fed’s motive for injecting reserves and paying interest on them.

      The only way that I can understand what the Fed was doing is to say that the goal was to stimulate bank profits, not the economy. If your goal were to stimulate the economy, you would inject enough reserves to do that and not pay interest on reserves. That might require buying some long-term bonds or mortgage securities, but not the hundreds of billions that the Fed actually bought.

      Everything the Fed has been doing over the past fifteen months makes sense if you think of their goal as transferring wealth from taxpayers to banks. If you try to explain it as an attempt to implement an expansionary monetary policy, you won’t even get past my high school students.

  19. Wow dude thats insane. How do they do that.


  20. All of this stuff is way over my head. All I know is that my betters are looking out for me and that I can sleep better (assuming I have a place to sleep) knowing they can continue to live in the comfort and security to which they are entitled and accustomed, maybe, that being the case they might let a few crumbs fall from their table to the rest of us.

    If all it takes is for them to have a few more yachts and a few more mansions at tax payer expense, well, that’s a small price to pay to have them looking out for we little folks.

Please to post comments

Comments are closed.