Monday, August 22, 2011

The Fed's Secret Lending Programs

Bloomberg came out with a comprehensive report on secret lending programs the Fed used from 2007 to 2010 last night. The most shocking thing about the report is the amount of money lent out to banks not only in the US but around the world: $1.2 trillion. As the Bloomberg article states, "Denominated in $1 bills, the $1.2 trillion would fill 539 Olympic-size swimming pools." Further, the $1.2 trillion is an even larger amount than the amount the government lent out in its Troubled Asset Relief Program, or TARP, which totaled $700 billion. The banks who received the most money are not surprising: Morgan Stanley, Citi, BofA. What is surprising is that the Fed found it necessary to bail out not only US banks but also foreign banks. In fact, RBS and UBS are both in the top 6 in peak amount borrowed. Also, many of the banks that received these secret loans were touting just how strong their liquidity positions were while receiving them! JP Morgan mentioned its "fortress balance sheet" at least 16 times while receiving secret loans peaking at $68 billion.

The Fed's stated goals are price stability and sustainable economic growth. So how does lending at below market rates to failing banks lead to either one of these? It certainly doesn't lead to price stability. As the below charts shows, food (something we all consume) prices are anything but stable. They are not only volatile but have a long term trend of increasing.

Higher food prices are due to the Fed printing money, and printing and lending to banks is of course inflationary.

So, maybe these loans have created sustainable economic growth then. Check out this chart of the S&P 500 priced in gold.

Why is the S&P priced in gold the most appropriate graph? Because the S&P in dollar terms includes increases due to the dollar being worth less. Like my previous post on gold, gold cannot be created out of thin air like dollars, so it has a stable supply. Another chart showcasing this economic (non)growth is the unemployment rate.

 Even if you believe the government's made up numbers, the unemployment rate indicates anything but economic growth.

So, what did the lending program actually do? It gave banks who took excessive risks even more money to take excessive risks. In a capitalist society, rewards should come for performing and penalties for not performing. The Fed is distorting this and is rewarding those banks who took too many risks, who were not smart, and who directly hurt the economy more money to play around with. This is like the losing team in sports receiving a prize while the winning team receives nothing. These nonperforming banks are being encouraged to keep on doing what they've been doing and the Fed has etched in stone that we will continue having the same problems we have been of excess risk taking.

For the full Bloomberg article, click here


  1. Imagine if the Fed was told to only keep inflation in check, what a stupid libertarian idea. Interested in what you look for when you invest in emerging markets (Russia, India, Brazil) and was wondering if you were planning on blogging on the subject?

  2. Yes having a dual mandate is certainly an idiotic thing but I'm sure if it was just to keep inflation in check, they'd screw that up somehow. As for investing in emerging markets, I've bought some foreign company's stocks that are listed in the US but only based on technicals and not fundamentals. I like the BRICs because they are commodity based economies and have tangible capital as opposed to a service sector economy like the US. The question for them is if they can survive without relying on the US and Europe for demand and become self-sustainable. Until this is clear, I would be cautious of them. Bullish long term, cautious short term.