Naked Capitalism’s Yves Smith: Fed’s $600 B cash injection may do no more than increase banker profits
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay, and we’re coming to you today from the PERI institute in Amherst, Massachusetts. And now joining us to talk about the $600 billion Fed move and what does it mean to the economy and to all of us is Yves Smith. Yves is the creator of the influential financial blog Naked Capitalism, author of ECONNED: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. Thanks for joining us.
YVES SMITH, BLOGGER AND AUTHOR: Thanks so much. My pleasure to be here.
JAY: So let’s see if I have this right. The Fed’s going to take $600 billion and buy government bonds that are owned by the big banks, except they’re not just going to buy them from the banks; they’re going to let other people buy them from the banks and then sell them to the Fed and make money on that. I mean, the whole thing seems rather bizarre. The critics are saying that this move, as many other moves at the Fed, seem to have absolute benefit for the big banks and relative to dubious benefit to the economy. So what’s your take?
SMITH: I would agree with that. What we’ve had, the Fed has been engaged in two efforts, only one of which has been somewhat successful. They’ve been trying on the QT to shore up the balance sheets of the banks. They had explicit programs during the crisis. You remember they had an alphabet soup of different rescue programs. And their second effort has been to have very low interest rates, in the hopes that bank would go out and lend in order to stimulate the economy, but also just to make a big spread between the low lending cost, the low borrowing cost, and what they were lending it on.
JAY: They’re getting money at zero.
SMITH: They’re getting money at zero, exactly. Now, what’s in fact turned out is that the banks have gone and instead have basically bought a lot of Treasuries. A significant amount of what they have done is, instead of lending, exactly, just go and purchase Treasuries. And even on that they’ve gotten a very big yield between, again, a zero cost to funding, or very close to zero cost of funding, and what they get on the Treasuries.
JAY: So they’re getting zero money here.
JAY: They go and buy T-bills.
JAY: And they’re earning interest on the T-bills.
SMITH: And they earn an interest.
JAY: So one arm of public money is financing them to earn money from another arm.
SMITH: Exactly. Exactly.
JAY: It’s a good business, but you need a lot of money to get into that business, don’t you?
SMITH: You need a lot of money to get into that business, exactly. And the whole point is that the banks have a lot of losses they haven’t yet recognized in the crisis, so this is a way to basically—without having any bills go through Congress that would be very unpopular, to recapitalize the biggest banks, which are the weakest. Now, then the Fed has another set of stories that it tells, and I honestly think that [Ben] Bernanke actually believes his PR. He has stories like this in various papers, but he said it in a more straightforward fashion in an op-ed in The Washington Post the day after the $600 billion so-called quantitative easing program was announced. First thing he said, this program has worked so far, which is absolutely untrue. The Fed did a first round of quantitative easing, and obviously we’re still at 10 percent—.
JAY: Okay. For everybody that hasn’t heard this yet, quantitative easing, if I understand it correctly, is increase the money supply, except I don’t want to say that, and they keep coming up with these cockamamie—.
SMITH: It’s specifically that they go out and do it by buying Treasury bonds, and they do it—the argument is they are doing it to lower yields, not just on short-term money, but to lower it on, you know, 10-year money, 30-year money that the Treasury borrows out. So the idea is if we lower—the theory is that if we lower rates on the lowest-risk assets, which are Treasury bonds, therefore it will lower rates on all the other assets, like mortgage bonds, and it will make equities a more attractive purchase. Basically, to put it another way, the notion is that by making Treasuries so unattractive to own, by making the interest you could earn on them so low, that investors will have to go out and buy riskier assets.
JAY: In other words, get back in the stock market.
SMITH: Get back into the stock market or get back into real estate, like a bubble.
JAY: So let’s create a stock market bubble—
JAY: —to supposedly get the economy running.
SMITH: And that’s the whole problem with this logic is the first time any central bank went on this program was Japan in the bubble era. Japan had a problem then that they had a very big export sector and very little in the way of domestic consumption, and they were getting a lot of pressure, particularly from the US, because it was such a mercantilist policy and it was taking so many jobs from a lot of other countries, but particularly, you know, the US. And Japan is de facto a military protectorate, so we do have a little leverage over Japan, unlike, you know, the situation we have now with China. So the Japanese went to engage in a similar program at very low interest rates to try to stimulate consumption, and the notion was, we’re going to pump up asset prices, we’re going to pump up real estate and stock market prices, and everybody will feel richer and they’ll spend more. Well, of course, all that they got out of that was a bubble and a 20-year bust. So this program has no history of success.
JAY: And a lot of furious retired people.
SMITH: Yes. Yes.
JAY: Which is a lot of what drove this election last Tuesday is anyone that hopes to live on interest income is furious right now.
JAY: More than furious. They’re getting poor.
SMITH: Exactly. So if we have the first part, which is it didn’t work in Japan, then we tried it when the economy was weak—you know, it was a different fact set then in Japan. [inaudible] when the economy is weak. QE1, there was one study done by a California academic who said that—Jim Hamilton, who said that for—.
JAY: QE1—quantitative easing one.
SMITH: Quantitative easing one. Right.
JAY: Not the the boat.
SMITH: Not the vote. Yes, exactly. QE1, quantitative easing one, because the Fed had an earlier program where they bought something like $300 billion worth of Treasury bonds and slightly over $1 billion of mortgage-backed securities, and he found that they only lowered long-term interest rates by 17 basis points. So that’s 0.17—17 hundredths of a percent. So for all the money they spent, it had only a very small impact on interest rates and obviously no impact on the economy. You know, it was Einstein who said, defined insanity as repeating the same behavior and expecting different results.
JAY: Okay. I’m a great believer that Bernanke and anyone that succeeded on Wall Street is not insane. So if the objective they’re claiming it is is—ain’t going to work, it means there is an objective that is going to work. So let’s back up a second. A whack of cash is now being put back into the hands of the big banks, they’re still making the spread on T-bills, and now they are selling off the T-bills. Why? Isn’t one of the reasons is they’re taking the cash now and they’re going to Brazil and they’re going to other places where they can earn even bigger spreads on their zero percent money?
SMITH: That’s correct. But that’s the big concern is that, you know, there’s a big pushback [from] a lot of the other banks and policymakers in other countries, because they say all this is going to do is stimulate inflation, that we’re going to have resumption—another finance term—of what is called the carry trade, which happened in Japan when, after Japan’s bubble era, they had a protracted period of very low interest rates. And what other investors would do is they would borrow in yen because the borrowing rate was very low, and then they would go buy assets in other currencies. And that—because—and when you do that, you actually wind up selling the yen, because if you’re going to—again, if you borrow in yen and you’re going to, say, invest in the New Zealand stock market, you have to sell your yen to buy New Zealand dollars. So the act of selling the yen makes the yen go down. So the the low interest rates and then the falling currency go together in this sort of carry trade. And the big risk is that [inaudible] something’s going to change and the yen goes up relative to the New Zealand dollar. You lose more on the currency than you saved on the interest rate. There is a risk in that trade.
JAY: So let me ask you a question. Is the reality of what’s happening here—forget all the rhetoric coming from the Fed and other places. It wasn’t that we were, a year and a half, two years ago, looking into the abyss. The finance system and the global economy was hanging on by fingernails, dangling. And what they’ve been able to do now is cover up the fact that we’re kind of still hanging, the finance system is still dangling, because there’s so much bad, toxic stuff that’s being hidden on the balance sheets of the big banks. So what the Fed’s really trying to do is bail out the big banks before this all explodes again and everybody finds out the financial system has no clothes.
SMITH: Right. That’s correct. But I also actually think that the Fed does believe to a degree the story they tell about quantitative easing, which I find, you know, that it will somehow stimulate the economy [inaudible]
JAY: But how? ‘Cause the banks are already sitting on $1 trillion they won’t loan. So now they’ll have $2 trillion to sit on [inaudible]
SMITH: Well, they believe that—no, I think that I—I tell you, I have to say that I think they believe it for different reasons, and everybody they talk to is in Washington and in New York, and those two economies are doing relatively well, so that they are getting feedback—they don’t go out in the real economy. They’re getting too much feedback from the wrong people.
JAY: Or is it just about how do we create another bubble and to hell with what’s going on on Main Street?
SMITH: Well, it could very well be that also. But the second thing is, when you’re talking about sort of the hanging on, the sort of the image that I use is what happened is we had the equivalent of a 500 pound man (which is our bloated financial sector) that’s already diabetic that then had a heart attack and went to an intensive care. And normally what you would take with the 500 pound diabetic man who had a heart attack is give him the quadruple bypass, you know, get him to lose weight, and as soon as he’s lost enough weight that he could exercise, go out and exercise. What we’ve instead done is put him in the hospital, he’s getting meds, and he’s ordering in from his gourmet restaurant, and his friends are bringing him bonbons when they visit, and so now he’s actually gained 50 pounds.
JAY: So he’s getting burgers and cherry pie intravenously.
SMITH: Right. Right. That’s correct. So, you know, we haven’t solved anything, and if anything the problem’s gotten worse, because the big banks that were too big to fail actually got more concentrated, because players like, you know, Bear Stearns were merged into the big banks, so the big banks got bigger.
JAY: So is part of this that if they don’t hide just how fragile and weak the banking system really still is, the market’s going to crash, there is no chance of getting their bubble going, and back to panic city?
SMITH: Right. Exactly. And the other thing that the regulators are doing, and the Fed is included, is something they call (again to use another technical term) regulatory forbearance. The banks are still carrying a lot of bad assets. You know, for example, they’re carrying a lot of second mortgages. And with housing down 25 to 45 percent, if you foreclose on the house, all that money is going to go to a first mortgage. There’s going to be nothing left for the second mortgages. They really should be written down quite a lot. And yet the banks, the four biggest banks, which are the ones that are most at risk, are still carrying them on their books at values of hundreds of billions of dollars, just writing down the second mortgages alone, which show these banks to be very weak. But they’re not being required to do that.
JAY: So if you understand this dynamic, I’m saying, and I’m sure people on both sides of the Fed and Goldmans and all the—if you’re on the inside of Wall Street, you know all of this. So what you’re doing is creating the bubble, because you know when to get out.
JAY: You’ll get out, the bubble will burst, and there’ll be another whack of people losing their pension funds and whatever.
SMITH: Except the funny bit is that they’re all telling themselves this. I mean, I even heard some of my investor friends were saying that they had—were basically—everybody, at least the investor types, and you presume the Wall Street types are thinking this way also, that the Fed’s creating a bubble, we’re going to ride the bubble, everybody’s all in. And the problem is this was the same mentality people had in early 2007. You could tell it was going to end badly, and everybody thought that, oh, we’ll just ride it and we’ll be able to get out on time, we’ll be able to save our hides. Even the professionals couldn’t. That’s why we had a crisis, that what happens in a crisis is suddenly the number of trades and the volume of trades you can do collapses and they can’t exit. They think they can exit in time, and the reality is the exit shrinks and only a very few people get through.
JAY: They’re going to get their bonuses, and too-big-to-fail is still too big to fail, so it doesn’t matter what the finance reform legislation was. We know it didn’t solve too-big-to-fail and they’ll come back again. So why not? What’s to lose, except the rest of the society has a lot to lose?
SMITH: Well, the one thing that might happen this time if we have a crash sooner rather than later is people [are] already profoundly angry with the banks. And if we have a crisis of some type in, I would say, the next 6 to 18 months, there’s going to have to be a pound of flesh for another round of bailouts. It’s not going to be acceptable for there to be another round of bailouts without at least the management of major firms being fired. I mean, there will have to be some price to pay.
JAY: And that will rip the Republican Party apart, because how do the Tea Party sign on to another bailout? And we know old-line Republicans will be there. I mean, Bush always was.
SMITH: Right. Right.
JAY: Okay. Segment two, we’ll come back, and we’re going to talk about what should be done, because the way it’s going don’t look good.
JAY: Thanks for joining us on The Real News Network. And come back for part two.
End of Transcript
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