Ellen Brown on Lender of Last Resort

Again we visit Ellen brown on the subject of thecapacity of central banks to produce fresh money.

This became necessary because reckless lendingbrought on massive financial losses.  Thereckless lending of the past decade hugely inflated the general credit grantingballoon, not just in housing either.  Itcontinues to support a whole universe of rather hairy loans to buy validassets.

When these losses were ‘monetorized’, it meantthat the losses stop been a direct threat to the economy itself.  After all, no market or economy can withstanda reset of housing prices back to 1950 levels of say $3,000 or the sufferingpressed by liquidating established businesses as occurred in the GreatDepression.

And yes, it is highly appropriate to use Fedcapacity to backstop obvious infrastructure build outs as is today happening inChinaand elsewhere.

Yet no one has done squat.

What the Fed Can do as "Lender of Last Resort"

Central Banking 101:
December 17, 2010
By Ellen Brown

We’ve seen behindthe curtain, as the Fed waved its magic liquidity wand over Wall Street.  Now it’s time toenlist this tool in the service of the people.

The Fed’s invisible hand first really became visible with the bailoutof AIG.  House Speaker NancyPelosi said in June2009:   

"Many of us were, shall we say, if notsurprised, taken aback when the Fed had $80 billion to invest -- to put intoAIG just out of the blue. All of a sudden we wake up one morning and AIG hasreceived $80 billion from the Fed. . . . So of course we're saying, Where'sthis money come from? ‘Oh, we have it. And not only that, we have more.’”

How much more -- $800 billion?  $8 trillion? 

The stage magician smilescoyly and rolls up his sleeves to show that there is nothing inthem.  “Try $12.3 trillion,” he says.  

That was the figure recently revealed for theFed’s “emergency lending programs” to bail out the banks.    

“$12.3 trillion of ourtaxpayer money!” shout the bemused spectators as pigeons emerge from theshowman’s gloved hands. “We could have used that money to build roads andbridges, pay down the state’s debts, keep homeowners in their homes!”

“Not exactly tax money,” saysthe magician with his mysterious Mona Lisa smile.  “When did you have$12.3 trillion in tax money sitting idle?” 

Not only did he not use “tax money;” it seems he hardly used “money” atall.  He just advanced numbers on a computer screen, amounting tocredit against collateral, replacing the credit that would have been advancedby the money market before the Fatal Day the Money MarketDied.  According to CNNMoney –

“[T]he Federal Reserve made $9 trillionin overnight loans to major banks and Wall Street firms during the Wall Streetcrisis . . . . All the loans were backed by collateral and all were paid backwith a very low interest rate to the Fed -- an annual rate of between 0.5% to3.5%. . . .

“In addition to the loan program for bond dealers,the data covered the Fed's purchases of more than $1 trillion in mortgages, andspending to back consumer and small business loans, as well ascommercial paper used to keep large corporations running. . . .
“Most of the special programs set up by the Fed inresponse to the crisis of 2008 have since expired, although it still holdsclose to $2 trillion in assets it purchased during that time.  The Fedsaid it did not lose money on any of the transactions that have been closed,and that it does not expect to lose money on the assets it still holds.”
Or so it is reported in the media. . . . 

The pigeons slip back up thesleeve from whence they came, a sleeve that was empty to startwith.  

The Central Bank asLender of Last Resort

Where did the Fed get this remarkable power?  Central banks are “lenders of last resort,” which means they are authorized toadvance as much credit as the system requires.  It’s all keystrokeson a computer, and the supply of this credit is limitless. According to Wikipedia:

“A lender of last resort isan institution willing to extend credit when no one else will. Originally theterm referred to a reserve financial institution, most often the central bankof a country, that secured well-connected banks and other institutions that aretoo-big-to-fail against bankruptcy.”

Why is this backupnecessary?  Because, says Wikipedia matter-of-factly, “Due to fractionalreserve banking, in aggregate, all lenders and borrowers areinsolvent.”  The entry called “fractional reserve banking” explains:

“The bank lends outsome or most of the deposited funds, while still allowing all deposits to bewithdrawn upon demand. Fractional reserve banking necessarily occurs when bankslend out funds received from deposit accounts, and ispracticed by all modern commercial banks.”

All commercial banks are insolvent.  They are unable to pay their debtswhen they come due, because they have double-counted theirdeposits.  A less charitable word, if this hadn’t all been validatedwith legislation, might be “embezzlement.”  The bankers took yourmoney for safekeeping, promising you could have it back “on demand,” thenborrowed it from the till to clear the checks of theirborrowers.  Modern banking is a massive shell game, and the banks arein a mad scramble to keep peas under the shells.  If they don’t havethe peas, they borrow them from other banks or the money market short-term,until they can come up with some longer-term source.

Ann Pettifor writes,“the banking system has been turned on its head, and become a borrowingmachine.”  Rather than lending us their money, they are borrowingfrom us and lending it back.  Banks can borrow from each other at thefed funds rate of 0.2%. They get the very cheap credit and lend it to usas much more expensive credit. 

They gotaway with this shell game until September 2008, when the Lehman Brothers bankruptcy triggered a run on the moneymarkets.  Panicked investors pulled their short-term money out, andthe credit market suddenly froze.  The credit lines on whichbusinesses routinely operated froze too, causing bankruptcies, layoffs andgeneral economiccollapse

Theshell game would have been exposed for all to see, if the Federal Reserve hadnot stepped in and played its “lenderof last resort” card.  QuotingWikipedia again:

“Alender of last resort serves as a stopgap to protect depositors, preventwidespread panic withdrawal, and otherwise avoid disruption in productivecredit to the entire economy caused by the collapse of one or a handful ofinstitutions. . . .
“In the United Statesthe Federal Reserve serves as the lender of last resort to those institutionsthat cannot obtain credit elsewhere and the collapse of which would haveserious implications for the economy. It took over this role from the privatesector ‘clearing houses’ which operated during the FreeBanking Era; whether public or private, the availability of liquidity wasintended to prevent bank runs.

“. . .[T]his role is undertaken by the Bank of England inthe United Kingdom (thecentral bank of the UK), inthe Eurozoneby the European Central Bankin Switzerland by the Swiss National Bank, in Japan by the Bank of Japan andin Russiaby the Central Bank of Russia.”

If all central banks do it, it must be okay, right?  Or is itjust evidence that the entire international banking schemeis sleight of hand?  All lenders are insolvent and are kept in thegame only by a lender-of-last-resort power given to central banks by central governments -- given, in other words, bywe-the-people.  Yet we-the-people are denied access to thiscornucopia, and are forced to pick up the tab for the banks.  Moststates are struggling with budgetdeficits, andsome are close to insolvency.  Why is the Fed’s magic wand not beingwaved over them?

QE3: Some CreativeProposals

According to financial blogger Edward Harrison, that might soonhappen.  He quotes a Bloomberg article by David Blanchflower, whom Harrison describes as “a former MPC[Monetary Policy Committee] member at the Bank of England but also anAmerican-British dual citizen professor who is very plugged in at theFed.”  Blanchflower wrote on October18:

“I was at the Fed last week in Washington for one ofits occasional meetings with academics . . . .

“The Fed is especially concerned aboutunemployment and the weak housing market. . . .

Quantitative easing remainsthe only economic show in town given that Congress and President Barack Obamahave been cowed into inaction.

“Quantitative easing” (QE) involves central bank purchases with moneycreated on a computer screen.  Blanchflower asked:

“What will they buy? Theyare limited to only federally insured paper, which includes Treasuries and mortgage-backedsecurities insuredby Fannie Mae and Freddie Mac. But theyare also allowed to buy short-term municipalbonds, and given the difficulties faced by state andlocal governments, this may well be the route they choose, at least for some of the quantitativeeasing. Even if the Fed wanted to, it couldn’t buyother securities, such as corporatebonds, as it would requireCongress’s approval, which won’t happen anytime soon.”  [Emphasisadded.]

You don’t need to understand all this financial jargon to pick up thata central banking insider who has sat in on the Fed’smeetings says that for the Fed’s next trick, it could and “may well” fund thebonds of local governments.  Harrison comments:

“The Fed can legally buy as many municipalbonds as it wants without congressionalapproval. . . . This is a big story.Blanchflower isessentially saying that the U.S. government can bail out both the housingmarket via Fannie and Freddie paper purchases and the state governments viaMuni purchases. And, of course, the banks get to dump these assets onto the Fedwho will hold them to maturity. I guarantee you this will have a very nice kicksince it is the states where the biggest employment cuts are.”

A big story indeed, opening very interestingpossibilities.  The Fed could use its QE tool not just to buyexisting assets but to fund future productivity and employment, stimulating thedepressed economy the way Franklin Roosevelt did but without putting the nationin debt at high interest to a private banking cartel. 

The Fed could, for example, buy special revenue bonds issuedby the states to finance large-scale infrastructure projects. They might builda high-speed train system of the sort seen in Europe and Asia.  Thestates could issue special revenue bonds at 0% or 0.5% interest to finance theproject, which could be repaid with user fees generated by the finishedrailroad.  The same could be done to build modern hospitals, develop waterprojects and alternative energy sources, and so forth.  All thiscould be done at the same extremely low interest rates now afforded to the banks,saving the states enormous sums in taxes. 

Wouldn’tthat sort of program be inflationary though?  Not under currentconditions, says author Bill Baker in a recent post.  Henotes that over 95% of the moneysupply is created by bank lending, and thatwhen credit is destroyed, the money supply shrinks.  The first roundof QE did not actually increase the money supply, because the money printed bythe Fed was matched by the destruction of money caused by debt default andrepayment.  To replace the debt-money lost in a shrinking economy,the Fed has already elected to embark on a program of quantitativeeasing.  The question addressed here is just where to aim the hose.

Closing the Social Security Gap

Anotherinteresting idea for QE3 was proposed by Ted Schmidt, associate professor ofeconomics at Buffalo State College. Writing in earlyNovember, Schmidt anticipated the cut in social security taxes now beingdebated in Congress.  Worried observers see these cuts as the firststep to dismantling social security, which will in the future be called“underfunded” and too expensive for the taxpayers tosupport.  Schmidt notes, however, that social security is a majorholder of federal governmentbonds.  The Fed could finance a $400billion tax cut in social security by buying bonds directly from the social security trust fund, allowing the fund to maintain its current levelof benefits.  Among other advantages of this sort of purchase:

“[I]t does not raise the gross national debt,because it simply transfers bonds from one government entity (the SocialSecurity trust fund) to a semi-government entity (the Fed); and . . . it givesthe Fed the extra ammo (treasurybonds) it will need when the time comes to restraininflationary pressures and pull reserves out of the banking system. (It doesthis by selling bonds to banks.)”

Schmidtconcludes: “Enough is enough, Dr. Bernanke!  It’s time to inject thepatient with money that gets into the hands of working people and smallbusinesses.”

TheFed’s lender-of-last-resort power has so far been used only to keep richbankers rich and the rest of the population in debt peonage, a parasitic andunsustainable endeavor.  If this power were directed into projectsthat increased productivity and employment, it could become a sustainable andvery useful tool.  Wethe People do not need to remain subject to a semi-private central bank thatwas ostensibly empowered by our mandate.  We can take our Money Powerback.

Ellen Brown is an attorney and theauthor of eleven books, including WEB OFDEBT: The Shocking Truth About Our Money System and How We Can Break Free.  Her websites are webofdebt.comellenbrown.com, and public-banking.com.

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