Before the Banking Act of 1935, the government was able to borrow directly from its own central bank.  Other countries followed that policy as well, including Canada, Australia, and New Zealand and they prospered as a result.  After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.”  Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much.  But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.     

Worse, it caused the Fed to lose control of where the money went.  Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes and that is apparently what is happening today.

In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers.  The problem was that 12 of these dealers – or over half -- are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others) and they evidently won the bids.     

The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1.  The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion.  Foreign bank cash reserves increased in lock step, by $630 billion -- or more than the entire QE2.

In a June 27 blog, John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote:   

In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. . . .

Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .  

[B]usiness loans continue to “tank” at the smaller banking institutions. . . .

The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.   

Tyler Durden concluded: 

. . . [T]he only beneficiary of the reserves generated were US-based branches of foreign banks (which in turn turned around and funnelled the cash back to their domestic branches), a shocking finding which explains . . . why US banks have been unwilling and, far more importantly,  unable  to lend out these reserves . . . .   

. . . [T]he data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! . . . This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded. 

Well, not exactly.  The fact that the QE2 money all wound up in foreign banks is a shocking finding, but it doesn’t seem to be the reason banks aren’t lending.  There were already $1 trillion in excess reserves sitting idle in U.S. reserve accounts, not counting the $600 billion from QE2. 

According to Scott Fullwiler, Associate Professor of Economics at Wartburg College, the money multiplier model is not just broken but is obsolete.  Banks do not lend based on what they have in reserve.  They can borrow reserves as needed after making loans.  Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds – meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.

Cheer


 

The state shutdown all but essential govt services on July 1 after Governor Mark Dayton, a Democrat, and Republican lawmakers are fighting over whether to raise taxes or cut spending.

This caused the state parks to close down throughout the Independence Day weekend and triggered the layoffs of more than 20,000 state employees. Road construction projects are on hold and highway rest stops are shuttered.

So heavy, in fact, that Ornstein is not convinced lawmakers will get past their partisan furies before markets go nuts and jolt them into action if only to raise the debt ceiling.

This much is known: Lawmakers must raise the nation's $14.3 trillion legal borrowing limit soon. The Treasury Department says that on Aug. 2 it will run out of money to pay the nation's bills in full and on time.

That's only a few weeks away. So what's it gonna take?

The group of lawmakers who participated in negotiations led by Vice President Joe Biden have already identified more than $1 trillion in budget cuts.

Republicans want far more.