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Dr. Kalinda Rose Stevenson
Greenspan’s Folly: Why Lack of Regulation By The Federal Reserve Is The Root Cause Of The Current Financial Mess
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John McCain claims that Wall Street greed is responsible for the current financial mess behind the bank failures and the subprime mortgage debacle. Michael Hirsh has written a significant article that places the blame squarely on the refusal of the Federal Reserve under Alan Greenspan to use its regulatory authority.
“Who is mostly to blame for the biggest upheaval on Wall Street since the Great Crash? The disaster appears to have many fathers. “In a way, it’s the perfect crime: Who do you go after?” asks Jim Rokakis, the treasurer of Cuyahoga County in Ohio, one of a slew of state-level officials who saw the mess coming years ago but were ignored by the Feds. “If you arrest the mortgage brokers, how can you in good conscience not arrest the officers of the mortgage banks and the rating agencies?” Rokakis wonders. Ultimately, a big share of the blame lies with Wall Street CEOs who encouraged all this bad lending by packaging it into ever more complex securities, and then invested in it themselves by the billions. Indeed, the myth surrounding the subprime fallout is that no single player along the pipeline could have prevented what happened, including the giant investment banks that loaded their balance sheets with this dreck only to have it drag them into oblivion. “Everyone’s to blame, and no one’s to blame,” says financial expert Joseph Mason of Drexel University, summing up a common view of academia and in Washington.
I don’t buy it. Especially the idea that somehow the blame lies mainly with Wall Street’s greed, as John McCain reiterated the other day, saying we have to “fix” it. How do you fix greed? And let’s face it, left to its own devices, Wall Street has always operated on pure adrenalized greed, which is why financial manias and bubbles come and go and always will.”
“This mess is mostly a titanic failure of regulation. And the largest share of blame goes back to one man: Alan Greenspan. People mainly fault the former Fed chief, who once enjoyed a near-saintly reputation because of his reputed “feel” for market conditions, for ushering in an era of easy credit that accelerated the mortgage mania. But the much bigger problem was Greenspan’s Ayn Randian passion for regulatory minimalism.” Read the rest of “Greenspan’s Folly” here.
Dr. Kalinda Rose Stevenson
Discover how Federal Reserve interest rates determine how much money banks have available to fund your business and real estate projects in No Money Limits For Real Estate Investors. Visit NoMoneyLimits.com for your Free ”52 Heart of Money Insights.”
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Why The Federal Reserve Is Keeping Its Fingers Crossed Under The Streetlight
On Tuesday, August 5, the Federal Reserve voted to keep the interest rate for banks unchanged. Although I am by no means an expert on the economy and the role of the Federal Reserve, the actions of the Federal Reserve often remind me of that old cartoon about the conversation between Bob and Joe under the streetlamp. Bob sees Joe looking at the sidewalk under the streetlamp and asks:
Bob: “What are you looking for?”
Joe: “My keys.”
Bob: “Did you lose them here?”
Joe: “No, I dropped them over there.”
Bob: “Why are you looking for them here, when you dropped them over there?
Joe: “There’s no light over there.”
The goal of the Fed is to control the money supply to prevent both inflation and recession. It’s easy to think of the Federal Reserve as a giant puppet master in Washington, able to pull the strings of the economy when it goes off track. As powerful as it is, the Federal Reserve is really a one-trick pony, with one major tool. It can raise or lower the interest rates that it charges banks for money.
“The Federal Reserve, confronted with the perils of a slumping economy and rising inflation, has decided for a second straight meeting to leave interest rates unchanged.
“The Fed announced Tuesday that it was keeping its target for the federal funds rate, the interest that banks charge each other on overnight loans, at 2 percent.
“Wall Street seem pleased with the decision. Share prices had been higher most of the day after oil dropped to around $118 a barrel. They gained a little more speed when the announcement came in as expected and the central bank didn’t tip its hand on when it might begin raising rates again. Federal Reserve
The Fed’s problem is that its main policy tool–setting interest rates for the banks–can only address one problem at a time.
To get back to Bob and Joe, the real problem is “over there, but the Fed can’t fix that problem, so it stands under the streetlamp, looking for a solution in the wrong place.
The two big threats facing the economy right now are inflation and recession. What can the Fed do when inflation is not the result of interest rates but the cost of oil? What can the Fed do when recession is not the result of interest rates but a result of the housing, mortgage, and credit crises?
“Federal Reserve Chairman Ben Bernanke and his colleagues are being forced to navigate treacherous waters, trying to keep the economy from plunging into a deep recession while worrying about keeping interest rates so low that they could trigger a dangerous inflation spiral.
“The Fed is really locked in right now. They can’t go forward or backward,” said Sung Won Sohn, an economics professor at the Smith School of Business at California State University Channel Islands. Stuck In Quagmire
What effect does the Fed’s decision to hold the banks’ prime lending rate at 2 percent have on inflation when the primary cause of inflation is oil prices?
Consider what happened in the 1970s, when oil prices shot through the roof and the Federal Reserve raised interest rates. The result was “stagflation,” an era of both inflation and stagnant growth in the economy.
But the most important element in the war against inflation was the Federal Reserve Board, which clamped down hard on the money supply beginning in 1979. By refusing to supply all the money an inflation-ravaged economy wanted, the Fed caused interest rates to rise. As a result, consumer spending and business borrowing slowed abruptly. The economy soon fell into a deep recession. Stagflation in the 1970s
Once again, we have rising inflation, triggered mostly by oil prices, and either the imminent threat or reality of recession as a result of the housing, credit, and mortgage debacles. What is the Federal Reserve doing in response?
“Responding to a severe credit crisis, the Fed last September launched an aggressive effort to cut interest rates. It reduced the funds rate seven times, lowering it from 5.25 percent, where it had been for more than a year, down to 2 percent in April.
“At the Fed’s last meeting on June 24-25, Fed officials passed up the chance to cut rates again. Instead, they signaled growing concerns about inflation pressures that have been made worse this year by surging oil prices, which hit a record high at $147.27 per barrel on July 11. Stuck%20In%20Quagmire %20
“>Stuck In Quagmire
The decision on August 5, 2008 to keep the prime lending rate unchanged is not so much smart strategy as recognition that the Federal Reserve can’t do much to prevent inflation or control recession.
So, will the Fed’s decision help the economy? Wall Street responded favorably, but it is important to note that Wall Street was already responding favorably because oil prices have fallen.
“The oil market also helped soothe some of Wall Street’s worries – crude fell as low as $118 a barrel before settling at $119.17, down $2.24 on the New York Mercantile Exchange. Oil has now fallen $28 from its July 11 high of $147.27 on widening expectations that the slumping U.S. economy will keep curbing consumer demand for gasoline and other petroleum products. Stocks close sharply higher after Fed decision.” Federal Reserve Holds Key Rate
Taken as a whole, the economy is affected by many forces. Many of these forces are far beyond the control of elected officials and the actions of any agency, such as the Federal Reserve. Although the actions of the Federal Reserve are powerful, they are not all-powerful. And so, the Fed makes its decisions under the streetlamp, and keeps its fingers crossed that keeping interest rates for banks unchanged for now will buy time for other economic forces to work.
By Dr. Kalinda Rose Stevenson
Discover how Federal Reserve interest rates determine how much money banks have available to fund your business and real estate projects in No Money Limits For Real Estate Investors. Visit NoMoneyLimits.com for your Free ”52 Heart of Money Insights.”
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How The Fed Controls The Money Supply
Have you seen the news reports that the Federal Reserve has “pumped” money into the economy? Have you wondered exactly what that means? How exactly does the Fed “pump” more money into the system?
Controlling the amount of money in the system is one of the most important functions of a government. Money is never simply personal. It is a matter of government policy. The more you understand how governments increase and decrease the amount of money available, the more you will be able to control your personal economy.
In the United States, the central bank is the Fed, or Federal Reserve. Every nation has an equivalent central bank. These banks monitor current economic conditions and respond if the central banks want to heat up or cool down the economy.
Although the news media use this type of language, they don’t explain exactly how the Fed increases or decreases the amount of money. What does the Fed do when the media report that the Fed is “pumping money” into the economy to calm fears of an economic panic? What does it do to “drain money” from the system, to cool it down?
Before we figure out what it means, let’s establish clearly what it does NOT mean. The Fed does not pump money into the system by printing out more currency. Currency is not equivalent to money.
The Fed has several tools it can use to decrease or increase the amount of money in the system.
The first tool the Fed uses is to adjust the reserve requirement of banks. The “reserve” is the portion of customer deposits that the bank must keep. It cannot loan all of its deposits.
If you have ever wondered how banks make money, they make it by loaning out customers deposits to other customers. However, the bank cannot loan out all of its deposits. If you deposit $1,000 in the bank, the bank loans most, but not all, of your $1,000 to other customers.
The Federal Reserve sets the reserve requirements for banks. Typically, the reserve ranges from 3-10% of its deposits. So, with your $1,000 deposit, the bank needs to keep on reserve only $30 with a 3% reserve and $100 with a 10% reserve. The bank is free to loan out whatever is left after the reserve requirement. With a 3% reserve the bank can loan out $970 of your money. With a 10% reserve, the bank can loan out only $900.
If the Fed wants to increase the money supply, it can reduce the reserve rate. If the Fed wants to decrease the amount of money in the system, it increases the reserve requirements. This simple example demonstrates how the process works, and how the Fed pumps money into and drains money out of the system by changing the reserve requirements.
When the bank has to keep 10% of its deposits on reserve, it can loan out only 90% of its deposits. When the bank has to keep only 3% of its deposits on reserve, it can loan out 97% of its deposits to customers. With a lower reserve, more money is available. With a higher reserve, less money is available. .
It is a bit misleading to claim that the Fed “pumps” money into the system. In fact, the Fed allows the banks to “pump” more money into the system, because the Fed has reduced the reserve rate. The lower the rate, the more money the banks can pump into the system. The ability of the Fed to change reserve requirements is one powerful tool Fed uses to control the amount of money in the economy.
By Kalinda Rose Stevenson, Ph.D.
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